Financial ratios: can you

trust them?

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I hi ii ice tif t use ~ ‘I ciii :t Tv cciv ttl:uic
80
ii ulillvuences, we tie bitted iu~ u tinclude thu
p~~~p•. iii the same sri tt,r caii hive ~vtitflv
5 65 caning ratios fir rtSasol IS tufter uhtait geliliuilt’
dtllcicituic iii it tiuunuiuu_ ~‘vi
85
Maic Gardiner CPA and liii iuialltt’
Katharine Bagshaw ACA reckon that financial
70 I pu~e a,uiithcr cs:uiuj’Ir. svh;ui exact lv
ratios (lust like
us ittg’~ It is it.? i ttiilv tuuu that st’\ersil iii
u!t:tt
accountants) are certainly 1. tICS rxlsi (e I! debt ic itui v dcht/ t’.stlst anti
10 important but they do have their that they tail he altulaled in different was.90liii
limitations! rx:iuuiphc. do they take :i~ it 11111 III slit ii - t criu ci
cdiii tis, kitig—tcrtit pit ~vtsu ~uic such is
gearing (and of p tlecuclitit to
~tti rntfil)
t’. 1st-ill iii t cser’,es, nit her I ban
ti~tut :ilistttg ii
\Xhei, :tlutilai ii~’. civ debtir days or 51(1(15
itt, nicer, tict we take ~c:tu tud it
accuage halaut t clii liptiuc ( i’s-i-it :icttu
aging iSti I ‘:ti;t p clue, .fl~t urus ntighut fail
In relli I II tt:tI ~:ti Ii? tins ) When we
htiitk am uluttI eSi unset, salt titlIst be taketu ti itt
liii’ iSi ‘‘55 Iliteiesi figure 5111(1 tint an inlttt’ct exp-
tu.i 11gw that titinhtt lie net of itti-ic;? lit ItSil ii
muitciec, t’a1ijl;lllsrii I hittitiec lali’tt lii~ti iluc
caslihlow statciliculi tat, bt’ a tuctf,,l abet native
Iii the 1’&I . in stuchi iascsf.

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75
;uullciins and it xcc, and uutiu)t’tilV inter e’.ic? I lii t’tiillit:ti itl~’ uiIiltut (ill C(%tIiiy,

hiis submit iuut:tngihihec ihi:ti have been

95 must t’ttucidt’i whet I i~EiTi’”~iiipaii~’’TThs I
writicul till tt
et’aIUC(I its assets ~q not tt~iss’tt tic rcvalu~
ationc ptutiitce a higher cquit~ ba(‘Xhlt’t ti’’
I hiese prtiilt’iius uuia~’ be keener iii the t JK
100 wlut’uc sti’ has-i no Itlitittum chart of
isv iii its iii :~ grtititidi;i~ in acci ii tilts and su lict t nit ‘IC’ atu(uttntiu)g oplutuls Cliv a
ii :tIIil I ititti iii p1 liii tilt iii lititti putt tit. Ti luittigli it cut t epiahie in ihic scaith fiur a ‘trite and ar View. Euit
t;lian cnuuipaiiies should, in theiirv1 lie e;odcr
15 ( ittil utiivclv) issiItIle(i III 1P~ Iii deal tvitli in this respect as u hey iii ten
15t, Is I)~L 55:1? IS hascil Pitt 105 hi:ts’e tiunre rigtir— pifls pit-it? :ilIiiuu
taut itituiptut is itti vu ving tu~iivu vutu~ t’uiuIciiitec and Inure sire— Sii uptis C staiud:ti I’
~ii tilt iplec hits Iiit;liis Lll:It :t( UI1T alt’ liutait II owl-vet the level utl dtali’stiic IS tilli-it
20 Pi ‘tpulIlRattilv host, th;tui in i lie (I K, and utt t
uiuucc s’:tr)Ijtt the I i~.) C’ tint he tli:tplt svithniit n ‘_ (iutittil
(ev’ut nints may well lie based u~ lax i egtul:ui it ins
able iiiititiuit (if nddii l(li1~iI I (~Ji icli ii id CVCt~ I PSI ~itci1Ieflt 110 tat fir I hart nuitin— hug su:iiitlai ds
I ~vcii our i\ruiei ut api ti tusins luavi’ bin—
lit p os~—l it ‘rtltr alia)vst c sil tual ion~ I lie pit plilcuit is ititi tlatiieiit:uhly dii It-i -iii lItlitIlul ing priult tpks ~fl
25 Iit’t unitijit ttilt(I1(l liv iiii~tii— till I i~ II tutu ing tIit Itt t’it(t’,. (er! Pun areas stit:h as goodwill and asset
I tespit c iii is. i rattil utitut I iieiftnut~aulte utti taints ci icli vakiattitti, ic iii be cvii limit the manda— t nrc ~ iS (
as prutit ulargilt. lvi urn un taitial titipitived (R(~( I~. 115 ;A,~I ‘ I ec-itt~ihuai it in retitlired from the TM or
“:tinings pci cit 1-~ companies listed in the tJ~A. I ti example.
I l’’~ ) Hill tile price tat lungs P-Ft the latest I !uiilcvrr It ii~ffl5 cliuiw su (1K. (AAI’
30 iii lit ivtdii’ 1’tihhishctl anti used iii drisiitu-tuiaking, ificti return on cqutt if ~ I ~ hut ihe equivalent hiS
tine MUSpCC1~ ct’nhti~ itiv t’r’rit aticnhjtifl lititig paiçi ti svltai Fig— nrc onIn gtmucial ietuuic,’ we can ectisiulci
hut itthituid I IIC1It ~( ~T CX1ill~ilC~ hauls crc dii iii itug 120 ihuit iluert’ ui i five icc tic to be es’;ihi,ua ti-ti by a
agencies, audit ut 5, ituvestuient fiuiauit u:th aui:ul~-si iii i rder to tsui~n a conu—
met ‘pr nit itltiISItltiIt tc~iiliS pTChCI ii ‘u’ ~1C~ nrc iii u it ti iflitI P,
35
-I the Fitiaticial ~ rs~ ail uw such l~nan— Ju,1,f,f ti-i/i it lilt?”
iii i.’ ‘c in their July wnrk 125
I lii’cc ui 111111’ h’~~’h itertis stult IS gltt
If stc ‘it gel the niaxitlilnul itihi ma— tutu fu4~uul :t tif i Ills, nuargill, t; ~(‘tit iuug mat gin and net unatgin1 as
40 5cr iluitci first t~t well is pt’rfouuiiancc measures such as tile
retItu II liii flcset, itO :ipii:ul cunphnuvid, aiitl itri
ill P t~’i thi:it cp,tl:tt&l ticlinittutic (hi unit t\tst h,ti txaiiuiilc, ‘‘
130 cuhitilv ‘shut’ itttt-.t it uittiiulitlg choices aiftut 1itlii ilii st
tat exulTs is includ— I Iii IltitilCI itil ati Icfliuiliui:llir III dv (e.g t’apitalisiutiumu of ,‘;i,? ii tlt(iiIeiIhtu
(suihiceqiietit ililtit ulc:utttut ). this t :iieCuir’y is
45 tin i’ll c:u;~iunt &iti~ htivt’~ h~ )( )~ rartkuharfv dii ficuult ii’ Utiflipit ‘‘ aniungci
ittitild capital etiipi,uvt include dclii :lli~~ tiillIiiiV iuiltusts iii ccilip:iltics in
lutiI~

lack uf tilisistcuti clelittiricins is tx:u in tied liv the

50 fiR t that ttn,tuttdcrlving
it I t)ffl~ P t~ p l~t. ICS till whicit L!ie liguit Is
tfttiuicl~~ arc based an 1w cugutulis .i~ lv
iii Ii ciii. I t ts:tiiujtk’. lies die ciiuilpaui

55 ulti ipice j~i it -au Ic Its fixed assets tip it; ititu l: -i able sect lilt
icc? l)oes it cliii in Cap ti:ilict uit’velnpuitcni ~ucts, nr tnt-i ;i,
till mutt titliuill hiuitjt’Ct~ 1 itiw tltit’’. it tical

is sun asset ~t as a charge

60 ;igsun1~u iqluitv?
 the same country, let alone across borders.
Again. ii is also worth remembering that 25
110 stand:ird definition of key ratios such as
R(Fccists.
5 issues such as asset valuflli(in arid the
I tqiluitr’( (Ilk! cpu/is’tucs’ i’tttI’(
‘these balance sheet ru ins include the cur— upt atich
30
quick i :utitic. which give tic an
intliciuinui of how well the organisation manages its
10 working capital and operating cycle, In the case of the tutu
rent ratio, the benchmark is often said to be around I S lint
35
stat i;i us chow that the UK average is ill tact sc--TI below
this level.
15 1 ccut sf/u uu’itt’i’ 1011)1
Stuck turnover, debtor days, total asset IturnovetSand
similar raticts are all relcvanu tit an evaluation 40of
efficiency, which itself
drives profit. Idle or slow-moving assets are had news for
20 the investor, and manaeen’lent will he blamed. In addition
to the
i :tti(l values themselves, the trend fruiti year to s-car45is
considered equally impor(alit.
It is ‘vorth noting, however, that inter-
national norms do vary—the average riivtiicc
50
payment period iii the UK is around 15 days
and in Italy around 90 (lays! Accounting
trt’atlncnl of goodwill lii’
55
again inuportant wheii making mci—corn—
ian’ comparisons
Gu’utting ‘arl(is
ft l’~ gearing levels un on iveranc mitch lower
60
titan in, sa, (jilt un lx’, cs-lucre the banks have
traditionally provided the htlk ol company
finance. Accounting and re~iuirting issues
which are again significant here intl title quesi
ii it tc of (lcbt/eqttiuy clas— sificatioru, asset
valuation, valuation of iicuisitin fund Iiabihii 65
icc,
and the treatmeult of finance leases auth
deferu-ed taxes. Furu Itcrrnou e, a key quest inn
is ‘are all liabilities in b-’ considered sic debt’?
70
Juts’ i/o,’ (iti~iu kui) i’~i’c
Although of limited interest to the lender,
unvestor are particularly keen on knowing
such statistics as FPS, PIE, dividend vieli,
cash flow per share and the total utuarket
eapitabsatiot). In fact several of these sIt-
tistics at-c calculated and published by the
yr every day.
In aldition t(i 5(iiilC tif the accounting
issues already mentioned above, important
market-driven international variations do
exist, in P/Ia ratios for example, and these
are only partly expIain~d by accounting
differences.
Itt ciuncluslon, it scenic that ratios (just !
~ke accountants) are certainly important,
hut do have their limitations!
A-tart (izi’lruci’ will he explonng these tcnsec
/,iu thu-u’ in ‘F:iuancial l?aruo Ana!ssr’t ‘ eta
Srpn’mI’ ‘i itt i,)ubhn. For further t n/ormarrou
(‘(ttIIcICt 1)1/lIlA /%ltti(P((t?(P’SC? tO 0171 917
92-1-i
Mat aqemenl At ct tIlt itt, uq ~0i 11011 iber ‘1~1f