FINANCIAL RATIOS AND MEASURES REVIEW

RATIO ANALYSIS
Ratios can be used as indicators of business health or impending problems. There are two main approaches to ration analysis: Vertical Comparison of figures within one financial period. Comparison of figures from different financial years.

Horizontal

UNDERSTANDING RATIOS
Ratios must be interpreted after considering the economic and industrial conditions applying to the organisation. Ratios should be compared over time to determine the factors that have caused changes in the results and determine specific trends. Ratios should be compared to performance indicator (KPI). a reasonable

Ratios can assist to performance analyse any item or sub total in a profit & loss.

GROSS MARGIN %
Gross Profit --------------- X 100 Revenue

Measures the adequacy of trading profit or margin

PROFITABILITY %
EBIT --------------- X 100 Revenue

Critical measure of operational performance before tax and interest

Earnings Before Interest and Tax

TAX
EBIT
COST OF SALES

OUTPUT

BANK SHAREHOLDERS

SALES

VARIABLE COSTS

GROSS PROFIT

FIXED COSTS
CONTRIBUTION..

DIVIDENDS

INTEREST EBIT TAX PROFIT BEFORE TAX NET PROFIT

RI

NET PROFIT TO SALES

Net Profit --------------- X 100 Revenue

Measures the final net profit rate after tax and interest

PROFIT MANAGEMENT

Product

Service Yield Control of Costs Optimum Volume

P S Y C O

ACCOUNTS RECEIVABLE COLLECTION RATE

Accounts Receivable -----------------Revenue

365

Measures Accounts Receivable Collection Rate

Appropriate Time Period

ACCOUNTS PAYABLE COLLECTION RATE

Accounts Payable -----------------COGS

365

Measures Accounts Payable Payment Period

INVENTORY TURNOVER

Inventory -----------------COGS

365

Average Inventory =

Measures the level of inventory turnover (Shelf Life of Stock)

Opening Inventory + Closing Inventory 2

CURRENT RATIO

Current Assets -----------------Current Liabilities

Working Capital % =
Accs Rec. + Inventory Accs Pay./ Revenue * 100 * Time Period

Basic test of the ability to pay debts

ASSET TURNOVER RATE

Sales --------------Net Assets

How much in sales are generated from each $1 of capital invested in net assets

A negative amount CASH FLOW shows that cash flow has increased.
Short Term + Long Term Debt (Last Period) Short Term + Long Term Debt (This period)

Measures The change in externally borrowed

funds from one period To the next

WHY GO INTO BUSINESS?

To get a To Get a Return On Capital Employed

Or ROCE

THE ACCOUNTING EQUATION

Equity Assets Liabilities

=
Shareholders funds Fixed assets Debtors Inventory Other current assets Cash

Bank overdraft Other short term debt (eg lease, Hire purchase & taxation Liabilities) Creditors

Retained Profits & reserves

THE ACCOUNTING EQUATION

Net Debt + Equity = Total Operating Assets (Capital Employed)

How the Business is funded =

How the funds are applied in the business

FINANCE

Capital Employed

DEBT CAPITAL
Bank Loans Bank Overdraft Leases Hire Purchase

EQUITY CAPITAL
Share capital Retained Income Reserves Other Equity Funding

OPERATIONS
Operating Working Capital
Accounts Receivables Inventories Other Current Assets (Accounts Payables)

NON-CURRENT ASSETS
Investments Intangibles Buildings Plant Equipment

Net Assets

COMPONENTS OF ROCE
EBIT
Revenue

Revenue
Net Operating Assets

X 100

Measures Profit and Loss Management

Measures Balance Sheet Management

RETURN ON CAPITAL EMPLOYED (ROCE)

One measure that combines both profit and loss management and balance sheet performance Is measured before any financing cost to enable comparisons to be made with the average cost of finance Is critical to the assessment of value creation