Ratio analysis
LIQUIDITY RATIO: a) Current Ratio=
Current assets Current liability
X : 1
Sufficient current assets to cover current liabilities? General standard is 2:1. In excess of 2:1 indicates over- investment in working capital.
b) Quick / Acid test Ratio=
Current assets - Inventory X :1 Current liability
Inventory is excluded from the ratio because inventory is not a very liquid current asset. Some manufacturing companies hold large quantities of raw material stocks. Finished goods might be warehoused for a long time, or sold on lengthy credit. In such businesses stocks are not very liquid assets. If Current ratio is higher than Quick ratio, it means working capital is tied up in inventory. If quick ratio is comparatively very low, it indicates a lot of working capital tied up in stock and may encounter cash flow problems. General standard is 1:1. In excess of 1:1 indicates over- investment in working capital.
Liquidity ration: Current ratio and Quick ratio are below industry average: Poor level of liquidity. Utilizing liquid resources to finance fixed investments? Utilizing liquid resources to repay past borrowings? Industry growing too fast ignoring liquidity? Improve liquidity through disposing surplus assets and/or reducing stock level and/or speeding up debtors’ collection period and/or slowing payments to creditors. cre ditors.
PROFITABILITY PROFITABILITY RATIO: a) Profit Before Interest & Tax (PBIT) = Profit before taxation taxation + Interest charges charges on long-term loan capital b) Capital Employed = Total asset - Current liability
Or, = Share capital + Reserves + Long-term liability c) Return On Capital Employed (ROCE) =
PBIT Capital Employed
100%
X%
This ratio indicates how efficiently a business is using the funds available (equity and long-term debt). It measures how much is earned per $1 invested. It is thus a measures of the efficiency and effectiveness with which the managers have made use of the resources available to them.
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Ratio analysis
ROCE uses profit which is not directly linked to the objective of maximizing shareholders wealth. If increase from previous year or above industry average: good sign and reflects the fact that the company has managed to increase sales without a proportionate increase in costs. If decrease from previous year or below industry average: problem with control of costs. Level of dividend has also fallen.
d) Return on equity (ROE) =
Profit after tax & preferred Dividend 100% X % Ordinary share capital & reserve
Indicates to ordinary shareholders how well their investments has performed Measures how much profit a company generates for its ordinary shareholders with the money they have invested in the company.
Profitability ratio: ROCE and ROE are above industry average: Favorable condition. Non-current assets ever not been revalued? Revaluation could depress these ratios.
e) Asset turnover ratio =
Capital employed
X :1
Nrt profit
100% X % Sales Higher percentage indicates: costs are being controlled; sales prices are high compared to costs
g) Gross profit percentage =
This shows the turnover that is generated from each $1 worth of asset employed. The higher the turnover per $1 invested the more efficient use of the assets employed.
f) Net profit margin =
Turnover ( Sales )
Gross profit Sales
100% X %
High: Effective purchasing strategy. Concentrating on low volume, high margin sales Low: selling its products cheaply in order to generate more sales.
h) Operating profit percentage =
Operating profit Sales
100% 100%
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Ratio analysis
EFFICIENCY RATIO: a) Receivables Collection Period=
Trade Receivable s Credit sales
An approximate measure of the length of time it takes for a company’s customers to
pay what they owe. Receivables collection period similar with payables payment period represent better credit control policy. Normally Receivables Collection Period is less than 30 days. Significantly in excess of this might be representative of poor management of funds of a business. However, some companies such as exporting companies must allow generous credit terms to win customers. If the collection period is increasing year on year, this might show a poorly managed credit control function, and an increased risk of bad debts. However, increase in receivables collection period might be a deliberate policy to increase sales by offering better credit terms than competitors. Adversely affect the cash flow position if early payment and late receipts happen.
b) Stock / Inventory Turnover Period=
Avg. Inventory Cost of Sales
Or, = c) Payable Payment Period=
365 days XX days
Trade Payable Credit Purchase
365 days XX days Cost of sales Avg. inventory
X times
365 days XX days
Less than 30 days: sufficient cash to pay its payables promptly. More than 30 days: indicate that may have liquidity problem.
INVESTMENT RATIO: a) Earnings Per Share (EPS) = Profit after interest,tax and preferencedividend Number of ordinary shares Or,
Market price of share
Pr ice earnings ratio
X $
X $
A key measure of company performance from an ordinary shareholder’s point of view. Shows the amount of profit attributable to each ordinary share. Increase in EPS generally indicates success. Both right issue and bonus issue result in a fall of EPS. So, care must be taken when interpreting. Decrease in EPS will not be welcomed.
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Ratio analysis
EPS does not represent actual income of the shareholder. Rather, it represents the investor’s share of profit after tax.
b) Dividend Per Share (DPS)= c) Dividend payout ratio =
c) Dividend Cover=
DPS EPS
100%
Earnings / profit after tax and preference dividend X times Ordinary dividend
d) Price Earnings (P/E) Ratio=
Total ordinary dividend Announced X $ Total number of ordinary share
Market price per ordinary shareshare X EPS
Basic measure of a company’s performance from the market’s point of view.
P/E ratio expresses the amount of money shareholders are prepared to pay for the share as a multiple of current earnings. It expresses the current share price as a multiple of the most recent EPS. Higher P/E ratio indicates possible better performance of the company in the future, may be rise in profit. Dividend per share 100% X % Market price per share f) Share Price = P/E X EPS e) Dividend Yield=
DEBT & GEARING RATIOS: a) Debt / Equity Ratio=
b) Gearing ratio =
c) Leverage=
Or, =
Total debts *100% X % Total assets
Loans Preferred shares Ordinary shares All reserves
*100% X %
Shareholde rs' equity Shareholde rs' quity total long term debt Shareholde rs' quity Total assets - current liabilitie s
d) Interest Cover =
PBIT X times Interest charges
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Ratio analysis
T 10 a) Raw material stock turnover / holding period =
b) Accounting rate of return =
c) Avg. return =
Avg. profit or return Avg. investment
Raw material Cost of purchase
* 365
*100% X %
Accumulate d profit Accumulate d depreciati on Life of the project
d) Avg. investment =
Initial investment Scrap value
2
F9: FM: Financial gearing
= = =
Operational gearing = = =
Long term debt
Pr eference share capital
Ordinary share capital and reserves
X 100%
Long term debt Pr eference share capital Share capital
Re serves Long term debt
X 100%
Pr ofit before int erest X 100% Pr ofit after int erest Fixed cos ts Total cos ts
X 100%
Fixed cos ts Variable cos ts Contributi on PBIT
X 100%
X 100%
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