Interpretation and Analysis of Financial ratios

Ratios
It is the term applied to the results of calculations used to compare the
performance of the businesses .It is a generic term applied to the
results expressed in:
* True ratios, e.g a current ratio might be 4:1
* Percentages,e.g. a gross margin might be 58 percent.
* Time. E.g a trade receivables turnover might be 32 days.

Ratios helps the manager of the business to analyse and make decisions related to;
* Profitability of the business
* Liquidity of the business
* Efficiency of the business
 Ryan Plc
Income Statement for the year ended 31 December
2015 2014
Particulars Amount $ Amount $ Amount $ Amount $
Revenues 2600 2000
Less : Cost of Sales
Opening Inventory 110 90
Purchase 1460 1240
Closing Inventroy (120) 1450 (110) 1220
Gross Profit 1150 780
Less : Expenses
Administrative Expenses 340 140
Selling and Distribtuion Expenses 310 650 180 320
Profit from Operations 500 460
Less Finance Cost 46 22
Profit before Tax 454 438
Less Tax 145 151
profit for the year 309 287

Ryan Plc
Statement of Changes in Equity
for the year ended 31 December 2014
Retained Earnings Amount $
Opening balance as on 1 Jan 2024 595
add Profit for the year 309
Total Profit Available 904
Less: Dividend paid 55
Closing balance as on 31 Jan 2024 849
 Ryan Plc
Statement of Financial Position for the year ended 31 December
2015 2014
Particulars Amount $ Amount $ Amount $ Amount $
Assets
Non-Current Assets 3063 1800
Current Assets
Inventories 120 110
Trade Receivables 240 220
Cash & Cash Equivalents 140 500 570 900
Total Assets 3563 2700
Equity and Liabilities
Equity
Ordinary Shares 1500 1500
6% Preference shares 100 100
Retained Earnings 849 595
Total equity 2449 2195
Non- current Liabilities
8% Debentures 800 200
Current Liabilites
Trade payables 169 154
Taxation 145 151
Total Current Liabiliites 314 305
Total Liabilities 1114 505
Total Equity & Liabilities 3563 2700
 1 Profitability Ratios ( all answers expressed in %)

Expenses to Revenue = Expenses to Reven

i 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠/𝑅𝑒𝑣𝑒𝑛𝑢𝑒x100=..% Operating Expens
Gross margin (%)
Mark up (%)
Profit margin (%)
Operating Expenses to Revenue = (𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 ROCE (%)
ii
𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠)/𝑅𝑒𝑣𝑒𝑛𝑢𝑒x100

iii Gross margin = (𝐺𝑟𝑜𝑠𝑠

𝑝𝑟𝑜𝑓𝑖𝑡)/𝑅𝑒𝑣𝑒𝑛𝑢𝑒x100

iv Mark up = (𝐺𝑟𝑜𝑠𝑠
𝑃𝑟𝑜𝑓𝑖𝑡)/(𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠)x100

v Profit margin = (𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒

𝑡𝑎𝑥)/𝑅𝑒𝑣𝑒𝑛𝑢𝑒x100

vi Return on Capital employed

ROCE = (𝑃𝑟𝑜𝑓𝑖𝑡 𝑓𝑟𝑜𝑚
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛)/(𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑)x100
profit from operation =profit before interest and tax
capital employed = total capital = equity+ncl
Expenses to Revenue ratio
Operating Expenses to Revenue
Gross margin (%)
Mark up (%)
Profit margin (%)
ROCE (%)
 2Liquidity Ratios

i Current ratio = (𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠

)/(𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 )=2:1 (eg)

ii Quick ratio = (𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 )/(𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠)=

0.65:1(eg)
Where Quick Assets = Current Assets - Inventory
QAL = Quick ratio, Acid test ratio and Liquid ratio

Current assets =Tap put Cash/cheques before u close it for the day
Trade Receivables (Debtors)
Accrued Incomes/Income Receivables
Prepaid Expenses
Cash /bank
Closing Inventory

Current liability =BATOS ; u r standing on bato bec uve a short term payable
Bank overdraft
advance income
Trade payables/Creditors
Outstanding Expenses
Short term payables ( eg tax payable )
Interpretation
The business has $ 2 worth of current assets to pay its $1 worth of Current liabilities

The business has $ 0.65 worth of quick assets to pay its $1 worth of Current liabilities
 1

ii

iii

vi
Efficiency Ratios

Trade receivables Turnover ratio = (𝑇𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠

)/(𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 )x365= ..days

Trade payables turnover = (𝑇𝑟𝑎𝑑𝑒

𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠)/(𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒)x365 =...days

Inventory turnover ratio = (𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)/(𝐶𝑜𝑠𝑡 𝑜𝑓

𝑠𝑎𝑙𝑒𝑠 )x365=..days

Rate of Inventory turnover = (𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠)/(𝐴𝑣𝑒𝑟𝑎𝑔𝑒

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)= ..times

Non current assets turnover = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒/(𝑁𝑒𝑡 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓

𝑁𝐶𝐴 )=..times
Net book value = Cost - accumulated depreciation
 3 Efficiency ratio ( Learn in this sequence)
days
i Trade receivables turnover ratio( days)
ii Trade payables turnover ratio (days)
iii Inventory turnover ratio (days)
times
iv Rate of inventory turnover
v Non current assets Turnover
 List of Ratios
1Profitability Ratios
i Expenses to Revenue ratio
ii Operating Expenses to Revenue
iii Gross margin (%)
iv Mark up (%)
v Profit margin (%)
vi ROCE (%)

2 Liquidity ratios
i Current Ratio
ii Quick Ratio/Acid test ratio/Liquid ratio

3 Efficiency ratio
in days
i Trade receivables turnover ratio( days)
ii Trade payables turnover ratio (days)
iii Inventory turnover ratio (days)
in times
iv Rate of inventory turn over
v non current asset turn over ratio
4
Interpretation
What is the % of expenses over Revenue ?
What is the % of operating expenses over Revenue ?
What is the % of Gross Profit over Revenue ?
What is the % of Gross Profit over Cost of Sales ?
What is the % of Net profit before tax over Revenue ?
What is the % of profit from opeartion over Total capital invested?

What is the ability of the business to pay Current Liabiliites using its Current
What is the ability of the business to pay Current Liabiliites using its Quick as

How many days is the business taking to collect its Trade receivables ( i.e cre
How many days is the business taking to Pay its Trade payables ( i.e credit sa
How many days is the business taking to convert its Inventories to Sales

How many times did the business convert its inventory to sales
How many times did the business earn revenue using it Non Current assets
what is good
low
low
high
high
high
high

high
high

low
high
low

high
high
 1 Profitability Ratios
Interpretation
1 Expenses to Revenue ratio =26.77%
2015
This means for every $100 worth of Sales the business made an nexpense of $ 26.77
2014
This means for every $100 worth of Sales the business made and expense of $ 17.1
The ratio has increased in 2015

2 Operating Expenses to Revenue

2015
This means for every $100 worth of Sales the business made an operating expense of $25
2014
This means for every $100 worth of Sales the business made an operating expense of $ 16
The ratio has increased in 2015

3 Gross margin (%)

2015
This means for every $100 worth of Sales the business made a gross profit of $44.23
2014
This means for every $100 worth of Sales the business made a gross profit of $39
The ratio has increased in 2015
4 Mark up (%)
2015
This means for every $100 worth of Cost of sales the business made a mark up of $79.31
2014
This means for every $100 worth of Cost of sales the business made a mark up of $63.93
The ratio has increased in 2015
5 Profit margin (%)
2015
This means for every $100 worth of sales the business made profit before tax of $17.46
2014
This means for every $100 worth of sales the business made profit before tax of $21.90
The ratio has decreased in 2015
6 ROCE (%)
2015
This means for every $100 worth of investment (capital employed) the business made profit from operation of $15.39
2014
This means for every $100 worth of investment (capital employed) the business made profit from operation of $19.21
The ratio has decreased in 2015

2 Liquidity ratios
i Current Ratio
2015
This means the business has $1.59 worth of current assets to pay $ 1 worth of current liabilities
2014
This means the business has $2.95 worth of current assets to pay $ 1 worth of current liabilities
The ratio has decreased in 2015

ii Quick Ratio/Acid test ratio/Liquid ratio

2015
This means the business has $1.21 worth of Liquid assets to pay $ 1 worth of current liabilities
2014
This means the business has $2.59 worth of Liquid assets to pay $ 1 worth of current liabilities
The ratio has decreased in 2015
Liquid assets means those current assets which can be easily converted to cash quickly in times of need
3 Efficiency ratio
i Trade receivables turnover ratio( days)
2015
This means the business takes 34 days in average to collect its trade receivables (credit sales)
2014
This means the business takes 41 days in average to collect its trade receivables (credit sales)
The ratio has decreased in 2015 means business is collecting faster.
ii Trade payables turnover ratio (days)
2015
This means the business takes 43 days in average to pay its trade payables (credit purchase)
2014
This means the business takes 46 days in average to pay its trade payables (credit purchase)
The ratio has decreased in 2015 means business is paying earlier (not good)
iii Inventory turnover ratio (days)
2015
This means the business takes 29 days in average to convert inventory to sales
2014
This means the business takes 30 days in average to convert inventory to sales
The ratio has decreased in 2015 means business is converting inventory to sales earlier (good)
times
iv Rate of inventory turn over (answers how many times ??)
2015
This means the business has converted inventory to sales 12.61 times
2014
This means the business has converted inventory to sales 12.2 times
The ratio has increased in 2015 mean business is converting inventory to sales many times (good)

v Non current assets Turnover (when u invest $ 1 in Non current how much sales are you making?_
2015
0.85 times ; This means for every $1 invested in non current assets the business earned $0.85 worth of revenues.
2014
1.11 times ; This means for every $1 invested on non current assets the business earned $1.11 worth of revenues.
The ratio has decreased in 2015 (not good)
The more revenue it can earn for every $1 investment in non current assets the better for business
 Income Statement
$
Sales 100
Less Cost of goods sold: 20
Gross profit 80
add other incomes 10
Total income 90
Less Expenses 30
Profit from operation 60
Less Finance charge 10
Profit before tax (profit for the year after interest ) 50
Less Tax 5
Profit after tax (profit for the year) 45
Limitations using ratios to assess the performance of the business.
1 Historic cost
2 Importance to Past results
3 Financial Statements only give an overview
4 Monetary aspects
5 Difficult to compare like with like
6 Use of different accounting policies
7 Window Dresssing
8 Seasonal business
 1 Historic cost
2 Importance to Past results
3 Financial Statements only give an overview
4 Monetary aspects
5 Difficult to compare like with like
6 Use of different accounting policies
7 Window Dresssing
8 Seasonal business

Extract Ebook pg 279 Ian Harrison