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. Horizontal Comparison of figures from different financial years.
UNDERSTANDING RATIOS <ul><ul><ul><li>Ratios must be interpreted after considering the economic and industrial conditions applying to the organisation. </li></ul></ul></ul><ul><ul><ul><li> </li></ul></ul></ul><ul><ul><ul><li>Ratios should be compared over time to determine the factors that have caused changes in the results and determine specific trends. </li></ul></ul></ul><ul><ul><ul><li> </li></ul></ul></ul><ul><ul><ul><li>Ratios should be compared to a reasonable performance indicator (KPI). </li></ul></ul></ul><ul><ul><ul><li> </li></ul></ul></ul><ul><ul><ul><li>Ratios can assist to performance analyse any item or sub total in a profit & loss. </li></ul></ul></ul>
GROSS MARGIN % Measures the adequacy of trading profit or margin Gross Profit --------------- X 100 Revenue
PROFITABILITY % Critical measure of operational performance before tax and interest EBIT --------------- X 100 Revenue
COST OF SALES FIXED COSTS VARIABLE COSTS TAX SALES GROSS PROFIT CONTRIBUTION.. EBIT NET PROFIT R I Earnings Before Interest and Tax DIVIDENDS PROFIT BEFORE TAX INTEREST OUTPUT TAX SHAREHOLDERS BANK EBIT
NET PROFIT TO SALES Measures the final net profit rate after tax and interest Net Profit --------------- X 100 Revenue
PROFIT MANAGEMENT P roduct Y ield S ervice O ptimum Volume C ontrol of Costs P S Y C O
ACCOUNTS RECEIVABLE COLLECTION RATE Measures Accounts Receivable Collection Rate X 365 Appropriate Time Period Accounts Receivable ------------------ Revenue
ACCOUNTS PAYABLE COLLECTION RATE Measures Accounts Payable Payment Period X 365 Accounts Payable ------------------ COGS
INVENTORY TURNOVER Measures the level of inventory turnover (Shelf Life of Stock) Average Inventory = Opening Inventory + Closing Inventory 2 X 365 Inventory ------------------ COGS
CURRENT RATIO Basic test of the ability to pay debts Working Capital % = Accs Rec. + Inventory – Accs Pay./ Revenue * 100 * Time Period Current Assets ------------------ Current Liabilities
ASSET TURNOVER RATE How much in sales are generated from each $1 of capital invested in net assets Sales --------------- Net Assets
_ CASH FLOW A negative amount shows that cash flow has increased. funds from one period To the next Short Term + Long Term Debt (This period) Short Term + Long Term Debt (Last Period) Measures The change in externally borrowed
To get a To Get a R eturn O n C apital E mployed Or ROCE WHY GO INTO BUSINESS?
Equity = Assets - Liabilities Shareholders funds Retained Profits & reserves Fixed assets Debtors Inventory Other current assets Bank overdraft Other short term debt (eg lease, Hire purchase & taxation Liabilities) Cash Creditors THE ACCOUNTING EQUATION
THE ACCOUNTING EQUATION Net Debt + Equity = Total Operating Assets (Capital Employed) How the Business How the funds are is funded = applied in the business
= Capital Employed Net Assets DEBT CAPITAL + EQUITY CAPITAL Operating Working Capital NON-CURRENT ASSETS + Bank Loans Bank Overdraft Leases Hire Purchase Share capital Retained Income Reserves Other Equity Funding Accounts Receivables Inventories Other Current Assets (Accounts Payables) Investments Intangibles Buildings Plant Equipment FINANCE OPERATIONS
X COMPONENTS OF ROCE X 100 Measures Balance Sheet Management Revenue Net Operating Assets EBIT Revenue Measures Profit and Loss Management
R ETURN ON CAPITAL EMPLOYED (R OCE ) <ul><li>One measure that combines both profit and loss management and balance sheet performance </li></ul><ul><li>Is measured before any financing cost to enabl e comparison s to be made with the average cost of finance </li></ul><ul><li>Is critical to the assessment of value creation </li></ul>
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