BAA6000 Advanced Performance Management

RATIO ANALYSIS

Common questions require knowledge of:

1. Calculations of ratios
2. Explanation of the ratio
3. Comment on the performance of the company, based on your calculations
4. Overall comment on changes

1. FORMULAS 2. EXPLANATION

 PROFITABILITY

(1) RETURN ON ORDINARY SHAREHOLDER’S FUNDS (EQUITY)

= Profit after Tax * 100% Percentage of profit available

Equity to equity shareholders

*** Equity = Ordinary Shares and Reserves

(2) RETURN ON CAPITAL EMPLOYED (ROCE)

= Profit from operations (PBIT) * 100% Profit generated from

Capital Employed Capital employed

*** Capital Employed = Long term Liabilities + Share Capital + Reserves (i.e. Debt & Equity)

(3) OPERATING (NET) PROFIT MARGIN

= Profit from operations (PBIT) * 100% Net profit generated

Sales from sales of the Co.

(4) GROSS PROFIT MARGIN

= Gross Profit * 100% Gross profit generated

Sales from sales of the Co.
BAA6000 Advanced Performance Management

 EFFICIENCY

(5) INVENTORY TURNOVER (DAYS)

= Inventory * 365 days Average number of days

Cost of Sales it takes to sell the stock

(6) RECEIVABLES COLLECTION PERIOD

= Trade Receivables * 365 days Average number of days

Sales it takes to collect debts

(7) PAYABLES PAYMENT PERIOD

= Trade Payables * 365 days Average number of days

Purchases it takes to pay our creditors

(8) SALES REVENUE TO CAPITAL EMPLOYED (ASSET TURNOVER)

= Sales How efficient Co. is in

Capital Employed generating sales from its resources

*** Capital Employed = Long term Liabilities + Share Capital + Reserves (i.e. Debt & Equity)

 LIQUIDITY RATIOS

(9) CURRENT RATIO (WORKING CAPITAL RATIO)

= Current Assets Measures the extent to which

Current Liabilities the Co. has sufficient current
assets to meet its current liabilities

Below 2:1 could be liquidity problems. Above 2:1, too many current assets.

(10) ACID TEST (LIQUID CAPITAL/QUICK RATIO)

= Current Assets – Inventories Measures the extent to which

Current Liabilities the Co. has sufficient current
assets that are quickly
convertible into cash to meet its
current liabilities.
BAA6000 Advanced Performance Management

 FINANCIAL GEARING

(11) CAPITAL GEARING

= Debt * 100% Measures the percentage of

Capital Employed debt finance to overall finance

***Debt = debentures/long-term loans, incl pref shares

**Capital Employed = Long term Liabilities + Share Capital + Reserves (i.e. Debt & Equity)

(12) INTEREST COVER

= Profit from Operations How many times the company

Interest payable could pay its interest costs out
of operating profit

 SHAREHOLDERS’ INVESTMENT RATIOS

(13) EARNINGS PER SHARE

= Profit after Tax Earnings attributable to

Number of issued ordinary shares each ordinary share, after tax.
Used by investors and
analysts. Expressed in pence.

(14) PRICE EARNINGS RATIO

= Current market price per share Comparison of the current

Earnings per share share price to its EPS

(15) DIVIDEND PER SHARE

= Total Dividend Dividend per share payable to

No. of shares Ordinary shareholders

(16) DIVIDEND COVER

= Earnings per share Shows proportion of profit

Dividend per share available for distribution to
shareholders and how much
has been re-invested into the Co.

(17) DIVIDEND YIELD

= Dividend on the share for the year * 100% Return expected by the
Current market value of the share shareholder
BAA6000 Advanced Performance Management

3. COMMENTS ON THE PERFORMANCE OF THE COMPANY, BASED ON

CALCULATIONS CARRIED OUT

Remember your audience!

Here you may need to state whether the ratio has increased/decreased or improved/
deteriorated from last year/industry average/another company.

Then you need to state reasons for the change.

Ratio Increase/Improved Decrease/Deteriorated

Less profits generated from

Return on More profits generated from
Shareholder’s investment in the company than from
Funds/ Equity other means/investments e.g. an ISA.
More profit generated per £1 of capital
Return on
employed. Therefore capital employed
Capital
is efficient. Compare to other
Employed
investments e.g. ISA/other companies
Generating more net profit from sales.
Due to increased sales margins or
Operating
decrease in expenses.
(Net) Profit
Compare to gross profit to see where
the increase has occurred.
investment in the company than from
other means/investments e.g. an ISA.
This can affect the amount
shareholders may want to invest in
the future
Less profit generated per £1 of
capital employed. Therefore capital
employed is not efficient.
Compare to other investments e.g.
ISA/other companies
Generating less net profit from sales.
Due to decreased sales margins or
increase in expenses.
Compare to gross profit to see where
the decrease has occurred.

Increased sales margins or reduction in Decreased sales margins or increase

Gross Profit cost of sales. in cost of sales e.g new supplier,
Examples same as opposite poor buying, competition

Takes longer to sell stock or Co. is

holding too much inventory.
Depends on business but usually shows
Inventory Poor stock control
good stock control
turnover (days) Problems with overstocking
Getting rid of old stock quickly
Increased amounts of older stock,
perhaps obsolete

Should be less than payables days.
Receivables Quicker in collecting money owed.
collection Due to good internal debt control
(days) procedures i.e. checking credit-
worthiness before giving credit
Takes more days to collect money
owed. Receivables may have
liquidity problems and could lead to
an increase in bad debts.
Poor debt collection procedures

Paying debts slower, keeping money

Payables Paying debts too quickly – inefficiency within the business. However, Co.
Payment of management to make use of credit should ensure they are still within
(days) terms or pressure from suppliers credit arrangements. Also could
indicate problems with liquidity
BAA6000 Advanced Performance Management

Decreasing sales from available

Asset
Increasing sales from available
Turnover/Sales
resources, however too high may
Revenue to
suggest insufficient assets to sustain
Capital
the level of sales revenue achieved.
Employed
Working
More current assets to meet liabilities.
capital/
Better liquidity
Current ratio
Better liquidity however, should
Acid Test/
compare to working capital, receivable
Quick ratio
collection and payables days
Depends on the culture of the industry.
Gearing
Lenders like to see 50% or less
The higher the better – looking for 2:1.
Company is likely to be able to meet
changing demands in interest rates.
Interest Cover
Lenders will like to invest and
shareholders are likely to receive
dividends and will also invest
More earnings attributable to each
EPS share than from other means,
e.g. an ISA
P/E ratio High confidence and expectations for
the company
resources. Could have been affected
by decrease in sales and/or increase
in net assets. A recent purchase of a
non-current asset would affect this
ratio, although benefit the ratio next
year
Decreased liquidity
Compare to Working capital,
receivable collection and payables
days. Decreased Liquidity therefore
perhaps not able to meet liabilities as
they fall due
Depends on culture of the industry
High debt/gearing – risk of not being
able to pay interest charges from
profits. After these payments there is
a risk that dividends cannot be
afforded and therefore returns to
shareholders could be volatile
Low ratio – company many get into
difficulties if the interest rates
increase. Affect whether Co’s will
lend you money and shareholders
unlikely to invest as less profits to
pay in dividends.
Could end up in liquidation
Less earnings attributable to each
share than from other means,
e.g. an ISA
Low confidence in the company,
could be due to poor performance or
even a high profile legal case
affecting perception of company

Dividend per
Increase in profits or change in Could be a drop in profits, or a result
share and
company dividend policy of a new share issue
Dividend Cover

Dividend yield Similar to above Similar to above

4. OVERALL COMMENTS

Always remember your audience!

Here you restate anything major from above, in terms of overall profitability, liquidity, use of
resources and Gearing. Your main focus should be on any changes i.e. if Gross profit margin
stays the same over the past two years you do not need to restate this - only give comments on
changes that have occurred and any reasons you anticipate for these changes.