Ratio Analysis - Overview

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Ratio Analysis - Overview

Learners should be able to: Calculate and interpret liquidity ratios: current ratio and acid test [AS] Calculate and interpret solvency ratios: gearing and interest cover Calculate and interpret efficiency ratios: creditor turnover, debtor turnover, non-current assets turnover, and stock turnover Calculate and interpret profitability ratios: gross profit margin, net profit margin, return on capital employed (ROCE) and return on equity [AS] Calculate and interpret shareholder ratios: dividend per share, dividend yield, earnings per share and price/earnings ratio Evaluate the financial position of a business Evaluate the usefulness of ratio analysis to a business and its stakeholders

What is Ratio Analysis? Ratio analysis involves the comparison of financial data to gain insight into business performance Compare against: Previous years Competitors (inter-firm) Industry average

It helps answer questions such as: Why is one business more / less profitable than another? What returns are being earned by shareholders in a business? Is the business solvent? Can it repay its debts as they fall due? How effectively is it using its assets?

Information comes from: Income Statement Balance Sheet (Statement of Financial Provision) Revenue Cost of Sales Gross profit Operating profit Net profit Current assets Current liabilities Inventories Trade receivables and payables Long-term liabilities Capital and reserves

Key stages in ratio analysis: Gather Data Calculate Ratios Interpret Results Take Action

Main Groups of Ratios & Stakeholder Interest PROFITABILITY Measures returns on trading & investment Shareholders Government Competitors Employees LIQUIDITY Can firm pay debts on time? Lenders Suppliers FINANCIAL EFFICIENCY Effectiveness of managing finances SOLVENCY /RISK Has the business taken on too much / little debt? SHAREHOLDERS Is it worth investing in the firm?