Analysis of Published Accounts & Investment Analysis  We know who the main users of accounts are  We know what’s involved in published accounts  But can we use them better ?

Analysis of Published Accounts & Investment Analysis  We know who the main users of accounts are  We know what’s involved in published accounts  But can we use them better ?  YES

Analysis of Published Accounts & Investment Analysis  To do so we use several ratios, all of which are for different information purposes.  You HAVE to know and remember how they are calculated and WHY they are calculated.  Nearly always part of the exams are – explaining ways in which a business can improve on disappointing performance based on ratio results.

Analysis of Published Accounts & Investment Analysis  What is ratio analysis ?  Accounting data, no matter how manipulated and interpreted, cannot solve problems and answer all questions on the business, as business behaviour cannot all be quantified.  Not always easy to use accounting data to asses performance.  Example:  Gale LTD$50 m  Severn LTD$500 m  At first glance what can you see ?  Is Severn more successful than Gale ?  Are the managers of Gale less effective ?  Are they becoming more profitable and good investments ?  Is Severn employing better strategies ?

Analysis of Published Accounts & Investment Analysis  What is ratio analysis ?  Accounting data, no matter how manipulated and interpreted, cannot solve problems and answer all questions on the business, as business behaviour cannot all be quantified.  Not always easy to use accounting data to asses performance.  Example:  Gale LTD$50 m  Severn LTD$500 m  At first glance what can you see ?  Is Higgins more successful than Gale ?  Are the managers of Gale less effective ?  Are they becoming more profitable and good investments ?  Are Severn employing better strategies ?  ANSWER – cant tell from the limited info

Analysis of Published Accounts & Investment Analysis  If we look at a little bit more:  Gale LTD $250 m turnover, $400 m capital employed  Severn LTD $3.2 Billion and $5 billion capital employed  We can now start to get a more detailed picture of performance, especially if you compare against earlier results.

Analysis of Published Accounts & Investment Analysis  The two types of ratios that will be required at AS level are Liquidity ratios and Profitability ratios.  Liquidity ratio

Analysis of Published Accounts & Investment Analysis  Return On Capital Employed (ROCE)  Most commonly used one in assessing profitability  Compares profit with the capital which has been invested in the business  ROCE = NP / CE X 100  So.....  Gale LTD NP $50m, CE $400m  Severn LTDNP$500m, CE $5b

Analysis of Published Accounts & Investment Analysis  Return On Capital Employed (ROCE)  Most commonly used one in assessing profitability  Compares profit with the capital which has been invested in the business  ROCE = NP / CE X 100  So.....  Gale LTD NP $50m, CE $400m  Severn LTDNP$500m, CE $5b  Gale 50 / 400 X 100 = 12.5%  Severn500 / 5,000 X 100 = 10%

Analysis of Published Accounts & Investment Analysis  Key points  The higher the value the better return you are getting  The result can be compared with the return from interest accounts – could the capital be invested in a bank at a higher rate of interest ?  ROCE can only be increased by increasing the profitable and efficient use of an asset.  The method for calculating this ratio is not universally agreed upon because of the different industries  ROCE is not related to the risks involved within business.  A high rate of return maybe because the business has undergone a successful risk taking exercise that has paid off rather than become more efficient.

Analysis of Published Accounts & Investment Analysis  Liquidity ratios  ALL DONE IN AS !!!

FINANCIAL EFFICIENCY RATIOS  INVENTORY / STOCK TURNOVER  You want low Capital use in holding stocks  Ratio records the number of times the stock is bought in and resold over a period of time  ITR= CoGS/ Value of inventories  So.....  Gale LTD CoGS $125m, Inv $25m  Severn LTDCoGS $2,400m, Inv $600m  Gale 125/ 25 = 5  Severn2,400 / 600 = 4

Analysis of Published Accounts & Investment Analysis  Key points  NOT a % - but “times” the stock has turned over  The higher the number, more efficient (JIT, strong management, effective promotions)  “normal” results will depend on the industry/ type of business  Service Sector firms – not relevant – no “stocks”

FINANCIAL EFFICIENCY RATIOS  DAY’s SALES IN RECEIVABLES RATIO  Debtors collectors ratio  How long it takes to retrieve what is owed  Shorter is better  DSRR = Accs Rec x 365 / Sales Turnover  Gale LTD Acc Rec $75m, Sales TO $250m  Severn LTDAcc Rec $600m, Sales TO $3,200m  Gale 75 x 365 / 250 = days  Severn600 x 365 / 3,200 = 68.4 days

DAY’s SALES IN RECEIVABLES RATIO  Key points  No “right” or “wrong” (cash sales companies?)  A high number could be a “management strategy” (Good customer credit = more customers)  BUT, could also be down to poor debt management  So, shorten credit terms to improve the result  Refuse credit terms to bad payers  Conflict of departmental interests?  Marketing Strategies to increase sales v’s Finance chasing money

SHAREHOLDER or INVESTMENT RATIOS  DIVIDEND YIELD RATIO (%) Div per share / Current Share price x 100  DIVIDEND PER SHARE RATIO Total Annual Dividends / total no. of issued shares Di vidends No. SharesDiv/ Share Ratio Mkt share price Div Yield % Ratio Gale $1.50$0.15 x 100 = 10% $1.50 Severn $10.00$0.70 x 100 = 7% $10.00

DIVIDEND YIELD RATIO (%)  Key points  If Directors want an increased dividend but the share price does not change, the Div Yield will increase  Can be compared with other investments  Can be compared with previous years  A high Div Yield might not indicate a wise investment! Yield could be high due to a drop in share prices (concerns in the market for the future prospects of the business)

SHAREHOLDER or INVESTMENT RATIOS  DIVIDEND COVER RATIO Profit after tax & Interest Annual Dividends  How many times the ordinary share dividend could be paid out of current profits  The higher it is, the more able to pay “proposed” dividends  Higher margin to reinvest profits back into the business DividendsProfit aft. Tax and interest $ Div Yield % Ratio Gale = Severn =

DIVIDEND COVER RATIO  Key points  If a Director want to increase dividends to shareholders, with no increase in profits, the ratio will fall  Potential investors might query if this level of dividend can be sustained in the future  A low result = retained low profits for future investment