Storytelling With Ratios

8/2/2019 Storytelling With Ratios

1/12

Jonny Buchanan


2/12

Ratio analysis is boring Financial statements can be indecipherable

But... Combine the two, and you can start to

understand whats going on behind thenumbers.


3/12

Will I lose money if I buy this stock? Does this company match my risk profile?

Will the company go bust? What are the chances the company will grow? How effective is the companys

management?


4/12

Broadly, the areas ratios can help us with are:

Profitability: Compared to its turnover, is the

company making a good profit? Liquidity: Can the company pay its bills?

Management Activity: How fast is cash flowinginto and out of the business?

Risk: What is the risk of the company goingunder?


5/12

Return On Capital Employed = PBIT/CapitalEmployed x 100%

Higher is better Capital employed = shareholders funds + long-

term creditors (total assets current liabilities)

Net Profit Margin = PBIT/Turnover x 100%

Higher is better low might suggest high costs


6/12

Current Ratio = Current Assets/CurrentLiabilities

Quick Ratio = (Current Assets Stock)/Current Liabilities

As the current ratio, but takes into account thefact that stock is not always liquid.

Always look at the industry average. A lowratio may be the norm.


7/12

These ratios give an indication of the tradingeffectiveness of the business.

Debtor Days = Trade Debtors/Credit Sales x 365

The effectiveness of the business at collecting its debts.Shorter is better.

Creditor Days = Trade Creditors/Purchases x 365

The credit the business is taking from its suppliers. Longeris better.

Stock Turnover = Cost of Sales/Stock

The number of times stock was sold in the year.


8/12

Gearing:

i) Gearing = Loan Capital/shareholders funds x

100% ii) Gearing = Loan Capital/Capital Employed

(Debt + Equity) x 100%

Consistency is most important

Interest Cover = PBIT/Interest Expenses High gearing may not be a problem if interest

cover is high.


9/12

Look for higher year-on-year profit growth Higher P/E multiples can be expected

Expect higher gearing levels and lowerinterest cover


10/12

Look for low gearing and high interest cover Dont expect high year-on-year profit

increases Look for consistency in dividend payments &

dividend yields


11/12

Historic information, not current Financial statements can be manipulated

Different companies have differentaccounting policies (e.g. depreciation) When comparing ratios, the companies must

be comparable. You cannot interpret ratios in isolation e.g.

Recent takeover as explanation for fallingcosts (rather than management.)


12/12

Ratios can help you tell a companys story They can help you get a clearer picture of

where a company sits in relation to its peers. But... Ratios can be manipulated, and should

not be interpreted in isolation.

Documents

Storytelling With Ratios