# Ratio analysis

LIQUIDITY RATIO:
a) Current Ratio=
 

Current assets  X :1 Current liability

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.

PROFITABILITY RATIO:
a) Profit Before Interest & Tax (PBIT) = Profit before taxation + Interest 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  100%  X% Capital Employed

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.

mezbah.ahmed@hotmail.co.uk http://groups.yahoo.com/group/acca_bd/ 1

e) Asset turnover ratio =  Turnover ( Sales )  X :1 Capital employed This shows the turnover that is generated from each \$1 worth of asset employed. If decrease from previous year or below industry average: problem with control of costs.uk http://groups.yahoo.  Non-current assets ever not been revalued? Revaluation could depress these ratios. 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. h) Operating profit percentage = Operating profit 100% 100% Sales mezbah. f) Net profit margin =  Nrt profit 100%  X % Sales Higher percentage indicates: costs are being controlled. 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.Ratio analysis    ROCE uses profit which is not directly linked to the objective of maximizing shareholders wealth. Level of dividend has also fallen.co. Concentrating on low volume. sales prices are high compared to costs g) Gross profit percentage =   Gross profit 100%  X % Sales High: Effective purchasing strategy. The higher the turnover per \$1 invested the more efficient use of the assets employed.ahmed@hotmail.com/group/acca_bd/ 2 . high margin sales Low: selling its products cheaply in order to generate more sales. Profitability ratio: ROCE and ROE are above industry average:  Favorable condition.

com/group/acca_bd/ 3 . mezbah.tax and preferencedividend  X\$ Number of ordinary shares Market price of share  X\$ Or. Inventory  365 days  XX days Cost of Sales Cost of sales Or. Receivables collection period similar with payables payment period represent better credit control policy. If the collection period is increasing year on year. some companies such as exporting companies must allow generous credit terms to win customers. INVESTMENT RATIO: a) Earnings Per Share (EPS) = Profit after interest.ahmed@hotmail. =  X times Avg. Decrease in EPS will not be welcomed. Avg. Increase in EPS generally indicates success. this might show a poorly managed credit control function. More than 30 days: indicate that may have liquidity problem. increase in receivables collection period might be a deliberate policy to increase sales by offering better credit terms than competitors.Ratio analysis EFFICIENCY RATIO: a) Receivables Collection Period=    Trade Receivable s  365 days  XX days Credit sales   An approximate measure of the length of time it takes for a company’s customers to pay what they owe. Both right issue and bonus issue result in a fall of EPS.yahoo.uk http://groups. care must be taken when interpreting. inventory Trade Payable c) Payable Payment Period=  365 days  XX days Credit Purchase b) Stock / Inventory Turnover Period=   Less than 30 days: sufficient cash to pay its payables promptly. and an increased risk of bad debts. Significantly in excess of this might be representative of poor management of funds of a business. Adversely affect the cash flow position if early payment and late receipts happen. However. Pr ice earnings ratio      A key measure of company performance from an ordinary shareholder’s point of view. Normally Receivables Collection Period is less than 30 days. Shows the amount of profit attributable to each ordinary share.co. However. So.

yahoo. It expresses the current share price as a multiple of the most recent EPS.ahmed@hotmail.current liabilitie s Or.Ratio analysis  EPS does not represent actual income of the shareholder. Higher P/E ratio indicates possible better performance of the company in the future. Rather.uk http://groups. it represents the investor’s share of profit after tax. may be rise in profit. = d) Interest Cover = PBIT  X times Interest charges mezbah. 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= Total debts *100%  X % Total assets b) Gearing ratio = Loans  Preferred shares *100%  X % Ordinary shares  All reserves c) Leverage= Shareholde rs' equity Shareholde rs' quity  total long term debt Shareholde rs' quity Total assets . b) Dividend Per Share (DPS)= c) Dividend payout ratio = Total ordinary dividend Announced X\$ Total number of ordinary share DPS  100% EPS c) Dividend Cover= Earnings / profit after tax and preference dividend  X times Ordinary dividend Market price per ordinary shareshare X EPS d) Price Earnings (P/E) Ratio=     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.co.com/group/acca_bd/ 4 .

uk http://groups.Ratio analysis T 10 a) Raw material stock turnover / holding period = Raw material * 365 Cost of purchase b) Accounting rate of return = Avg.com/group/acca_bd/ 5 .ahmed@hotmail. profit or return *100%  X % Avg.co. investment = F9: FM: Financial gearing = = = Operational gearing = = = Long term debt  Pr eference share capital X 100% Ordinary share capital and reserves Long term debt  Pr eference share capital X 100% Share capital  Re serves  Long term debt Pr ofit before int erest X 100% Pr ofit after int erest Fixed cos ts X 100% Total cos ts Fixed cos ts X 100% Variable cos ts Contributi on X 100% PBIT mezbah. investment c) Avg. return = Accumulate d profit  Accumulate d depreciati on Life of the project Initial investment  Scrap value 2 d) Avg.yahoo.