Managing Finance and Budgets Presentation 7  Financial Ratios
Analysing Accounts <ul><li>Now that we have a reasonable grasp on the standard financial statements used by businesses, we...
Analysing The Balance Sheet <ul><li>Normally, you will require two Balance sheets in successive years, and you should look...
Interpreting Large Upward Changes <ul><li>Fixed Assets:  The business may have bought new plant, machinery or transport. T...
Interpreting Large Downward Changes <ul><li>Fixed Assets:  The business may have sold plant, machinery or transport. Again...
Analysing The Profit & Loss Account <ul><li>Some information can be obtained simply on the basis of  one year’s Profit & L...
What to look out for on the  Profit & Loss Account <ul><li>Has the business increased its  Turnover  ? </li></ul><ul><li>H...
The Different types of Ratio <ul><li>As discussed in the previous section, we will use three we different types of Ratio: ...
Three Profitability Ratios <ul><li>We look at three important ratios: </li></ul><ul><li>__________________________________...
Gross Margin Ratio  Example of the Calculation <ul><li>Calculation for 2002 Gross Margin :  </li></ul><ul><li>494,600   x ...
Net Margin Ratio  Example of the Calculation <ul><li>Calculation for 2002 Net Margin :  </li></ul><ul><li>242,600   x  100...
Return on Capital Employed (ROCE)  Example of the Calculation <ul><li>Calculation for 2002 ROCE :  </li></ul><ul><li>242,6...
Liquidity Ratios <ul><li>These Ratios seek to answer the question: ‘Can the business pay its way?’ </li></ul><ul><li>All o...
Ratios - Liquidity <ul><li>We look at two ratios: </li></ul><ul><li>______________________________________________________...
Current Ratio Calculation  <ul><li>Current Assets : </li></ul><ul><li>Trade Debtors £240,800 </li></ul><ul><li>Bank Accoun...
Acid Test Ratio Calculation  <ul><li>Current Assets excluding Stock : </li></ul><ul><li>Trade Debtors £240,800 </li></ul><...
Efficiency Ratios <ul><li>These ratios are concerned with the way that assets are used in an organisation. </li></ul><ul><...
Efficiency Ratios <ul><li>Stock turnover (days)  =  Average Stock Value x 365 </li></ul><ul><li>Cost of Sales </li></ul><u...
Stock Turnover Period  <ul><li>Opening Stock Value £261,000 </li></ul><ul><li>Closing Stock Value £300,000 </li></ul><ul><...
Average Settlement period for Debtors <ul><li>Trade Debtors £240,800 </li></ul><ul><li>Total Sales   £2,240,000 </li></ul>...
Average Settlement period for Creditors <ul><li>Trade Creditors £191,400 </li></ul><ul><li>Total Sales   £1,804,400 </li><...
Seminar 7- Activities <ul><li>Preparation:  read </li></ul><ul><ul><li>Chapter 7 (M & A 2 nd  Edition)  </li></ul></ul><ul...
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  1. 1. Managing Finance and Budgets Presentation 7 Financial Ratios
  2. 2. Analysing Accounts <ul><li>Now that we have a reasonable grasp on the standard financial statements used by businesses, we can use that knowledge to obtain information as to whether or not the business is functioning effectively. </li></ul><ul><li>Today we will look at the Balance Sheets and Profit & Loss accounts of one fictional manufacturing Company to analyse its performance over the past two years. What we learn here can be applied to real companies whose financial reporting has been made public. </li></ul>
  3. 3. Analysing The Balance Sheet <ul><li>Normally, you will require two Balance sheets in successive years, and you should look out for any large proportional changes to items within: </li></ul><ul><ul><ul><li>Fixed Assets </li></ul></ul></ul><ul><ul><ul><li>Current Assets </li></ul></ul></ul><ul><ul><ul><li>Current Liabilities </li></ul></ul></ul><ul><ul><ul><li>Long Term Liabilities </li></ul></ul></ul><ul><ul><ul><li>Capital & Reserves </li></ul></ul></ul>
  4. 4. Interpreting Large Upward Changes <ul><li>Fixed Assets: The business may have bought new plant, machinery or transport. This might be part of a deliberate strategy </li></ul><ul><li>Current Assets: The business may holding higher stock levels, carrying more debtors or simply have more cash in the bank. </li></ul><ul><li>Current Liabilities: The business may owe more to its creditors </li></ul><ul><li>Long Term Liabilities: The business may have taken out an additional Long Term Loan </li></ul><ul><li>Profit & Reserves: The business may have made a large profit over the year. </li></ul>
  5. 5. Interpreting Large Downward Changes <ul><li>Fixed Assets: The business may have sold plant, machinery or transport. Again, this might be part of a deliberate strategy </li></ul><ul><li>Current Assets: The business may holding lower stock levels, carrying fewer debtors or simply have less cash in the bank. </li></ul><ul><li>Current Liabilities: The business may owe less to its creditors </li></ul><ul><li>Long Term Liabilities: The business may have paid back a Long Term Loan </li></ul><ul><li>Profit & Reserves: The business may have made a loss over the year. </li></ul>
  6. 6. Analysing The Profit & Loss Account <ul><li>Some information can be obtained simply on the basis of one year’s Profit & Loss Account, but it helps very much to see the comparison with the previous year. </li></ul><ul><li>The main headings to look at are: </li></ul><ul><li>Turnover ; Compare to Cost of Sales </li></ul><ul><li>Gross profit ; Compare to Overheads </li></ul><ul><li>Net Profit (called the Operating Profit) </li></ul><ul><li>Earned Surplus </li></ul>
  7. 7. What to look out for on the Profit & Loss Account <ul><li>Has the business increased its Turnover ? </li></ul><ul><li>How big a proportion of the Turnover is taken up by Cost of Sales ? </li></ul><ul><li>How big a proportion of the Gross Profit is taken up by Overheads ? </li></ul><ul><li>Has the business made a Net Profit (called the Operating Profit) . Has this increased from last year? </li></ul><ul><li>Has the business made an overall profit ( Earned Surplus )? Has this increased from last year? </li></ul><ul><li>Can you identify the main reason for the overall profit or loss? </li></ul>
  8. 8. The Different types of Ratio <ul><li>As discussed in the previous section, we will use three we different types of Ratio: </li></ul><ul><li>1. Profitability Ratios </li></ul><ul><ul><li>How successful is the business? </li></ul></ul><ul><li>2. Liquidity Ratios </li></ul><ul><ul><li>Is the flow of cash sufficient to meet obligations? </li></ul></ul><ul><li>3. Efficiency Ratios </li></ul><ul><ul><li>How is the business using its resources? </li></ul></ul><ul><li>In each of these cases, we will use the data taken from the M & N Manufacturing Financial Statements. These are summarised on the handout and on the spreadsheet. </li></ul>
  9. 9. Three Profitability Ratios <ul><li>We look at three important ratios: </li></ul><ul><li>______________________________________________________________________________________________________________________________________________ </li></ul><ul><li>Gross Margin % = Gross Profit x 100 </li></ul><ul><li> Sales </li></ul><ul><li>______________________________________________________________________________________________________________________________________________ </li></ul><ul><li>Net Margin % = Net Profit before tax & interest x 100 </li></ul><ul><li> Sales </li></ul><ul><li>______________________________________________________________________________________________________________________________________________ </li></ul><ul><li>Return on Capital Employed (ROCE) = </li></ul><ul><li> Net Profit before tax and interest x100 </li></ul><ul><li> (Share Capital + Reserves+ LT Loans) </li></ul>
  10. 10. Gross Margin Ratio Example of the Calculation <ul><li>Calculation for 2002 Gross Margin : </li></ul><ul><li>494,600 x 100 = 22.1% </li></ul><ul><li> 2,240,000 </li></ul>DEFINITION: Gross Margin % = Gross Profit x 100 Sales Selec t Selec t
  11. 11. Net Margin Ratio Example of the Calculation <ul><li>Calculation for 2002 Net Margin : </li></ul><ul><li>242,600 x 100 = 10.8% </li></ul><ul><li> 2,240,000 </li></ul>DEFINITION: Net Margin % = Net Profit before Tax & Interest x 100 Sales Selec t Selec t
  12. 12. Return on Capital Employed (ROCE) Example of the Calculation <ul><li>Calculation for 2002 ROCE : </li></ul><ul><li>242,600 x 100 = 29.2% </li></ul><ul><li> 830,130 </li></ul>DEFINITION: ROCE % = Net Profit before tax and interest x 100 (Share Capital + Reserves+ LT Loans) Selec t Add Together
  13. 13. Liquidity Ratios <ul><li>These Ratios seek to answer the question: ‘Can the business pay its way?’ </li></ul><ul><li>All of these ratios look at the flow of cash in the company, and try to determine whether or not, at a particular point in time, the business has enough cash to pay what it owes. </li></ul><ul><li>Liquidity can be interpreted as the amount of cash, stock, and debt, which can be easily converted into cash, offset by those elements which are currently owed, such as trade creditors, tax & interest etc. </li></ul><ul><li>Liquidity Ratios summarise the current Working Capital situation </li></ul>
  14. 14. Ratios - Liquidity <ul><li>We look at two ratios: </li></ul><ul><li>____________________________________________________________________________________________________________________ </li></ul><ul><li>Current ratio = Current Assets Current Liabilities </li></ul><ul><li>_______________________________________________________________________________________________________________ </li></ul><ul><li>Acid test = Current Assets excluding stock </li></ul><ul><li> Current Liabilities </li></ul>
  15. 15. Current Ratio Calculation <ul><li>Current Assets : </li></ul><ul><li>Trade Debtors £240,800 </li></ul><ul><li>Bank Account £33,500 </li></ul><ul><li>Closing Stock Value £300,000 </li></ul><ul><li>£574,300 </li></ul><ul><li>Current Liabilities: </li></ul><ul><li>Trade Creditors £191,400 </li></ul><ul><li>Dividends Owing £20,100 </li></ul><ul><li>Corporation Tax Owing £21,860 </li></ul><ul><li>£233,360 </li></ul><ul><li>Current Ratio = 574300 = 2.5 </li></ul><ul><li> 233,360 </li></ul>
  16. 16. Acid Test Ratio Calculation <ul><li>Current Assets excluding Stock : </li></ul><ul><li>Trade Debtors £240,800 </li></ul><ul><li>Bank Account £33,500 </li></ul><ul><li>£274,300 </li></ul><ul><li>Current Liabilities: </li></ul><ul><li>Trade Creditors £191,400 </li></ul><ul><li>Dividends Owing £20,100 </li></ul><ul><li>Corporation Tax Owing £21,860 </li></ul><ul><li>£233,360 </li></ul><ul><li>Acid Test Ratio = 274300 = 1.2 </li></ul><ul><li> 233,360 </li></ul>
  17. 17. Efficiency Ratios <ul><li>These ratios are concerned with the way that assets are used in an organisation. </li></ul><ul><li>Some of these are very useful financial management tools for example the average stock turnover and the average credit period. These can be very useful in controlling the flow of cash in an organisation. </li></ul><ul><li>These ratios are important measures of how effective particular changes in management practice have been. </li></ul>
  18. 18. Efficiency Ratios <ul><li>Stock turnover (days) = Average Stock Value x 365 </li></ul><ul><li>Cost of Sales </li></ul><ul><li>_____________________________________________________________________________________________________________________________________________ </li></ul><ul><li>Debtors (days) = Total Debtors x 365 </li></ul><ul><li> Total Credit Sales </li></ul><ul><li>_____________________________________________________________________________________________________________________________________________ </li></ul><ul><li>Creditors (days) = Total Creditors x 365 </li></ul><ul><li> Credit Purchases </li></ul><ul><li>_____________________________________________________________________________________________________________________________________________ </li></ul>
  19. 19. Stock Turnover Period <ul><li>Opening Stock Value £261,000 </li></ul><ul><li>Closing Stock Value £300,000 </li></ul><ul><li>Cost of Sales £1,745,400 </li></ul><ul><li>Stock Turnover (Days) </li></ul><ul><li>= (261000+300000)/2 x 365 </li></ul><ul><li> 1745400 </li></ul><ul><li>= 58.7 days </li></ul>
  20. 20. Average Settlement period for Debtors <ul><li>Trade Debtors £240,800 </li></ul><ul><li>Total Sales £2,240,000 </li></ul><ul><li>Average Settlement Period for Debtors </li></ul><ul><li>= 240800 x 365 </li></ul><ul><li> 2240000 </li></ul><ul><li>= 39.2 days </li></ul>
  21. 21. Average Settlement period for Creditors <ul><li>Trade Creditors £191,400 </li></ul><ul><li>Total Sales £1,804,400 </li></ul><ul><li>Average Settlement Period </li></ul><ul><li>= 191400 x 365 </li></ul><ul><li> 1804400 </li></ul><ul><li>= 38.7 days </li></ul>
  22. 22. Seminar 7- Activities <ul><li>Preparation: read </li></ul><ul><ul><li>Chapter 7 (M & A 2 nd Edition) </li></ul></ul><ul><li>You should make sure that you have calculated all the ratios within this presentation, and have completely understood all the explanations. </li></ul><ul><li>Exercises: </li></ul><ul><li>M & A (2 nd Ed.) Exercise 7.3 (pages 239-240) </li></ul><ul><li>M & A (2 nd Ed.) Exercise 7.5 (pages 241-242) </li></ul>
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