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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.
Horizontal Comparison of figures from different financial years.
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 a reasonable
performance indicator (KPI). Ratios can assist to performance analyse any
item or sub total in a profit & loss.
Gross Profit --------------- X 100
Revenue
GROSS MARGIN %
Measures the adequacy of trading
profit or margin
EBIT --------------- X 100
Revenue
PROFITABILITY %
Critical measure of operational performance before tax and interest
COSTOF
SALES
FIXEDCOSTS
VARIABLECOSTS
TAX
SALES
GROSSPROFIT
CONTRIBUTION..
EBIT
NETPROFIT R I
Earnings Before Interest and Tax
DIVIDENDS
PROFITBEFORE
TAX
INTEREST
OUTPUTOUTPUT
TAXTAX
SHAREHOLDERSSHAREHOLDERS
BANKBANKEBIT
Net Profit --------------- X 100
Revenue
NET PROFIT TO SALES
Measures the final net profit rate after tax and
interest
PROFIT MANAGEMENT
Product
Yield
Service
Optimum Volume
Control of Costs
PSYCO
Accounts Receivable
------------------Revenue
ACCOUNTS RECEIVABLE COLLECTION RATE
Measures Accounts Receivable
Collection Rate
X 365
AppropriateTime Period
Accounts Payable
------------------COGS
ACCOUNTS PAYABLE COLLECTION RATE
Measures AccountsPayable Payment
Period
X 365
Inventory------------------
COGS
INVENTORY TURNOVER
Measures the level of inventory turnover(Shelf Life of Stock)
Average Inventory =
Opening Inventory +
Closing Inventory
2
X 365
Current Assets------------------
Current Liabilities
CURRENT RATIO
Basic test of the ability to pay debts
Working Capital % =
Accs Rec. + Inventory –
Accs Pay./ Revenue *
100 * Time Period
Sales--------------- Net Assets
ASSET TURNOVER RATE
How much in sales are generated from each $1 of
capital invested in net assets
_
funds from one periodTo the next
Short Term + Long Term Debt (This period)
Short Term + Long Term Debt
(Last Period)
MeasuresThe change in
externally borrowed
CASH FLOWA negative amountshows that cash flow has
increased.
To get a To Get a Return On Capital Employed
Or ROCE
WHY GO INTO BUSINESS?
Equity
=
Assets
-
Liabilities
Shareholdersfunds
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 EmployedCapital Employed
Net AssetsNet Assets
DEBT CAPITAL + EQUITY CAPITAL
Operating
Working CapitalNON-CURRENT
ASSETS+
Bank LoansBank LoansBank OverdraftBank OverdraftLeasesLeasesHire PurchaseHire Purchase
Share capitalShare capitalRetained IncomeRetained IncomeReservesReservesOther Equity FundingOther Equity Funding
Accounts ReceivablesAccounts ReceivablesInventoriesInventoriesOther Current AssetsOther Current Assets(Accounts Payables)(Accounts Payables)
InvestmentsInvestmentsIntangiblesIntangiblesBuildingsBuildingsPlantPlantEquipmentEquipment
FINANCEFINANCE
OPERATIONSOPERATIONS
X
Measures Balance SheetManagement
Revenue
Net Operating Assets
EBIT
Revenue
MeasuresProfit and LossManagement
COMPONENTS OF ROCE
X 100
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