Ratio for accounting and costing

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Ratio for accounting and costing

  1. 1. FINANCIAL STATEMENTS ANALYSIS • Is an assessment of the financial position of a business in past, present and futureFINANCIAL RATIOS ANALYSIS • Is a relationship of one number with another number2 TYPES COMPARISON i. INDUSTRY AVERAGES - Ratios of one firm are compare with other firms within the same size & at the same time. ii. TREND ANALYSIS - Compare ratios of present with previous yearsCATEGORIES OF RATIOS a. Liquidity Ratios b. Efficiency Ratios c. Leverage Ratios d. Profitability Ratios e. Market Ratios a. Liquidity Ratios Purpose – to determine firm’s ability to meet its maturing obligation (pay its current liabilities) i. Current Ratio (CR) = Current assets Current Liabilities ii. Quick Ratio/Acid test Ratio = CA – Inventories – Prepaid expenses CLTamoi Janggu 1
  2. 2. Low ratio- indicate firm may have difficulty to pay currentliabilities on time (less liquid)High ratio – firm may sacrificing some return because toomuch financial capital is tied up in CA (more liquid)If CR is high but QR very low – indicate that firm may havetoo much stockb. Efficiency Ratios/assets management ratio/activity ratios Purpose – to measure how effective firm in managing its assets to generate sales i. Inventory Turnover Ratio (IT) = COGS OR = Sales Closing Stock Closing Stock - IT shows number of times inventory is sold out and re-stock or “Turned over” per year - High IT – is good, it may indicate high sales volume/superior selling practices - Low IT – indicate excess or obsolete inventories ii. Average Collection period (ACP) ACP = Account Receivable X 360 days Credit Sales - measure length of time taken to collect money from debtors Low ACP – is good, it indicate that firm manage to collect money in a short period i.e credit policy is good High ratio – contra from the aboveTamoi Janggu 2
  3. 3. iii. Fixed Assets Turnover (FAT) FAT = Sales. Net Fixed Assets -Low FAT – indicate firm not fully utilized it fixed assets to generate sale. iv. Total Assets Turnover (TAT) TAT = Sales Total Assets Low ratio- indicate firm not generating sufficient volume of sales in relation to its total assets investments.c. Leverage Ratios/gearing ratios Purpose – to measure how much debts (liabilities) is use in business to buy (finance) assets i. Debt ratio (DR) = Total Liabilities Total Assets High ratio – is not good because the firm expose to high financial risk - firm may have problem to borrow money in the future ii. Time Interest Earn (TIE) = EBIT Interest Expense Low TIE – indicate firm is less ability to pay its interest by using EBITTamoi Janggu 3
  4. 4. d. Profitability Ratio Purpose – to measure the effectiveness of the firm to generate profit in relation to sales, assets employed and shareholders investment. i. GPM = Gross Profit Sales Low ratio- may indicate excessive sales discount ii. Net Profit margin (NPM) NPM = Earning available to common s/holders Sales - high ratio indicate firm is good in controlling administration expenses iii. Return on Assets (ROA) ROA = Earning available to common s/holders Total assets Low ratio may indicate – assets is not efficiently utilized or - profit is very low However, further analysis is necessary If NPM is not good – it could be because: - high COGS (i.e markup is not sufficient) or - if GPM is adequate- low NPM is because of high administration expenses If NPM is good but GPM is low- it could be because of low sale or high COGS. iv. Return on Equity (ROE) ROE = Earning available to common s/holders Common Equity = ROA (Du Pont equation) 1 – Debt ratioTamoi Janggu 4
  5. 5. ** Common equity = OSC + Reserves + Retained profit - it measure the firm’s return compare to total equity.e. Market Ratios - To measure the firm’s stock price to its earnings, cash flow and book value per share i. EPS = Earning available to common s/holders Number of ordinary share issued - Shows number of ringgit earned for each share for the period ii. Dividends per share (DPS) DPS = Ordinary dividends Number of shares issued - indicates the actual cash received by investor on their investment. iii. Price/Earnings (P/E) Ratio PE = Market price per share EPS - Shows how much investors are willing to pay per dollar of reported profitLimitations of Ratios Analysis – page 58 i. Multiple lines of business ii. Different accounting practices iii. Industry average may not provide a desirable target standard iv. Seasonal factors v. Ratios can be too high or too low vi. “Window dressing” techniques. vii. Combination of good and bad ratios.Tamoi Janggu 5
  6. 6. User of Ratios Analysisi. Creditors Short term creditors – interested in firm’s ability to pay loan promptly i.e liquidity ratio is important to them Long term creditor - interested in firm’s ability to pay interest regularly & principle once matured - also on liquidating value of the firm - i.e interested in debt ratio & TIEii. Management - to analyze, plan & control - interested in all of the ratiosiii. Equity Investors - interested in firm’s efficiency & growth prospects & high dividendsiv. Others – government, IRB, suppliers, employees & public at largeTamoi Janggu 6
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