Understanding & Managing Finance Seminar 7

Seminar Seven - Activities  Preparation: read Chapter 7 (M & A 2 nd Edition) Exercises:  Ratio Activity Spreadsheet  M & A Exercise 7.3 (pages )  M & A Exercise 7.5 (pages )

Starting Points  Describe what is meant by Financial Ratio Analysis, and outline the key steps in performing such an analysis.  State some of the categories we need to consider when we are examining accounts, and describe some of the factors which might affect our analysis.  Describe some of the Key Ratios within each category, and what they mean.

Select and calculate appropriate ratios Identify the question and the information required Interpret and evaluate the results The key steps of financial ratio analysis

Some Financial Issues to Consider Categories Profitability Efficiency Liquidity

Profitability 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 100 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 100 Sales Gross profit x 100 Sales Sales

Efficiency 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

Liquidity Current ratio Acid test ratio Formula Current assets_______________ Current liabilities (creditors due within one year) Current assets (excluding stock) Current liabilities

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

P & Q Hypermarkets

Calculating and Using the Ratios (1)  To what extent should a business extend credit to its customers?  McLaney & Atrill Exercise 7.3 Conday & Co. Solutions available after the seminar.

Calculating and Using the Ratios (2)  What should a supplier look for when deciding whether to supply a business customer?  McLaney & Atrill Exercise 7.5 Threads Ltd. Solutions available after the seminar.

Additional Material: Using the Ratios 1. What sort of Liquidity Ratio is acceptable? 2. What early-warning signs can be detected that a company may be heading towards insolvency and failure?

Average current ratio and average acid test ratio for 1996 for UK listed companies in various industrial sectors Mineral extraction 0.0 General industries Consumer goods Services Utilities Current ratio Acid test ratio

Current ratio Time 19X119X4 19X319X2 19X5 XYZ Ltd Industry average Graph plotting current ratio against time

Mean ratios of failed and non-failed businesses

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