This lecture consists of:
an overview
a ratio analysis
an interpretation of the ratio analysis.
Formal calculations are only the start. Ratios must be interpreted.
Overview
Identification of important trends over time
……YEAR PERIOD
Sales (revenue)
Net assets
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P………….……………….………………………..……..
E……………..……………………………………………
For example, Craigielaw plc
Year 7 Year 6 Year 5
Financial Accounting
Purpose of ratio analysis
The aim is to build up a picture of the performance of the company.
Absolute figures are of little value. They only provide insights if they can be
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For example, (a) Sales compared to gross profits
(b) ………..…………………..…………….
Uses
1. Allows predictions to be made of likely increases in profit given an anticipated increased
level of sales
2. Provides data that allows a judgement to be made about achievements and levels of
performance
To determine whether these levels of achievement are satisfactory, we need standards for
comparison.
(i) Compare with earlier years.
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(ii) Compare it with the companys plan.
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(iii) Compare with those of other companies in the same industry.
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Financial Accounting
(iv) Compare with industrial average.
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Additional comments
3. Ensure that the company has used consistent accounting policies over time.
4. No explicit attempt to take into account the effect of inflation……………..………………..……….
5. Many sources of information about competing companies performance:
6. Ratio analysis is a starting point in the interpretation of companies performance.
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Financial Accounting
Systematic approach to ratio analysis
Lecture examples will calculate the ratios for Year 2.
After the lecture, calculate the ratios for Year 1 and attempt to comment on the picture
presented by these ratios.
Compare your calculations and comments with the textbook, Section 13.7
Income statement (profit and loss account)
for the year ended 31 December Year 2
Year 2 Year 1
Financial Accounting
Statement of financial position (balance sheet) as on 31 December Year 2
Year 2 Year 1
Total liabilities
Statement of changes in equity
Market price on 1 March Year 2 202 pence
Market price on 1 March Year 3 277 pence
Financial Accounting
Directors propose a dividend of 6.0 pence per share.
Earnings per share Profit after tax for ordinary shareholders
Number of ordinary shares
Dividend per share Dividend payable to ordinary shareholders
Number of issued shares
Dividend yield Dividend per share ×100%
Share price
Financial Accounting
Return on shareholders equity Profit after tax 100%
Share capital + reserves
Operating profit on sales Operating profit (before interest and tax) 100%
Sales (revenue)
Total assets usage Sales (revenue) ×
Total assets 100%
Financial Accounting
Current ratio Current assets: Current liabilities
Inventory (stock) holding period
Average stock held
Cost of sales × 365
Suppliers payment period Payables (creditors)
Purchases × 365
Financial Accounting
Debt/equity ratio Long-term loans 100%
Ordinary share capital + reserves
Financial Accounting
(Assume depreciation £50 million)
(115 82)
(89 61)
(10 9)
Reduction in cash due to increases in current assets
(45 30)
(1,155 1,118 50)
Financial Accounting
Earnings before deducting:
interest
taxation
Free cash flow