1. Financial ratio classification
Categories
Profitability
Efficiency
Liquidity
Gearing
Investment

2. The key steps of financial ratio analysis
Select and calculate appropriate ratios
Identify users and their information needs
Interpret and evaluate the results

3. Return on ordinary shareholders’ funds Return on capital employed
Profitability ratios
Return on ordinary shareholders’ funds
Return on capital employed
Net profit margin
Gross profit margin
Formula
Net profit after taxation and preference dividend (if any) x Ordinary share capital + Reserves
Net profit before interest and taxation x 100 Share capital + Reserves + Long-term loans
Net profit before interest and taxation x Sales
Gross profit x Sales Sales

4. Efficiency ratios Formula Average stock turnover period
Average settlement period for debtors
Average settlement period for creditors
Sales to capital employed
Formula
Average stock held x 365 Cost of sales
Sales per employee
Trade debtors x 365 Credit sales
Trade creditors x 365 Credit purchases
_______Sales_______ Number of employees
_______ Sales__________ Long-term capital employed

5. The main elements comprising the ROCE ratio
Sales______ Long-term capital employed
Return on capital employed
multiplied by
equals
Net profit before interest and taxation sales

6. Liquidity ratios Formula
Current ratio
Acid test ratio
Operating cash flows to maturing obligations
Formula
Current assets_______________ Current liabilities (creditors due within one year)
Operating cash flows Current liabilities
Current assets (excluding stock) Current liabilities

7. Average current ratio and average acid test ratio for UK listed companies in various industrial sectors Source: Datastream data, February 2001
Chemicals
0.0
Electricity
Food and drugs retailers
Food producers
0.2
0.4
0.6
0.8
1.0
1.6
1.2
1.4
Household goods and textiles
2.0
1.8
Information Technology Hardware
Water
Current ratio
Acid test ratio

8. Profit before interest and taxation_ Interest payable
Gearing ratios
Gearing ratio
Interest cover ratio
Formula
Profit before interest and taxation_ Interest payable
Long-term liabilities _______ Share capital + Reserves + Long-term liabilities

9. The effect of financial gearing

10. Investment ratios Formula
Dividend per share
Dividend payout ratio
Dividend yield ratio
Earnings per share
Formula
Dividends announced during the period Number of shares in issue
Operating cash flow per share
Dividends announced for the year x 100 Earnings for the year available for dividends
Dividend per share/(1-t) x 100 Market value per share
Price/earnings ratio (P/E)
Earnings available to ordinary shareholders Number of ordinary shares in issue
Operating cash flows – preference dividends Number of ordinary shares in issue
Market value per share Earnings per share

11. Average dividend yield ratios1 2 6 5 4 3
Oil and gas
Construction and building materials
Chemicals
Engineering and machinery
Pharma- ceuticals
Tobacco
Food and drug retailers
Electricity
Water
Distribution
Restaurants and pubs
Banks
2.53
3.79
3.77
5.82
1.54
5.35
2.85
1.95
2.22
4.19
6.62
2.84
Source: Constructed from information in Financial Times, 8 December 2000

12. Average P/E ratios
Oil and gas
Construction and building materials
Chemicals
Engineering and machinery
Pharmaceuticals
Tobacco
Food and drug retailers
Electricity
Water
Distribution
Restaurants and pubs
Banks 25 30 35 20 15 10 5 40
13.91
10.21
13.38
8.53
11.60
17.93
26.84
22.51
12.11
9.89
16.83
41.50
Source: Constructed from information in Financial Times, 8 December 2000

13. Graph plotting current ratio against time
1997
2000
1999
1998
2001
XYZ Ltd
Industry average

14. Mean ratios of failed and non-failed businesses
+0.35
+0.45
+0.25
+0.15
+0.05
-0.15
-0.05
+0.1
-0.1
-0.2
0.78
0.79
0.65
0.58
0.51
0.37
0.44
0.0 1 2 3 4 5
Cash flow Total debt
Net income Total assets
Total debt Total assets
Non-failed firms
Failed firms

15. Mean ratios of failed and non-failed businesses
0.36
0.42
0.30
0.24
0.18
0.06
0.12
3.5
2.5
2.0
+0.15
+0.05
-0.05
-0.15
3.0 1 2 3 4 5
Working capital Total assets
Current ratio
No credit interval
Non-failed firms
Failed firms

16. Scatter diagram showing the distribution of failed and non-failed businesses
Current ratio
ROCE ratio
Non-failed businesses
Failed businesses