OHT 6 1 Analysing and interpreting financial statements

OHT 6. 1 Analysing and interpreting financial statements OBJECTIVES You should be able to: Identify the major categories of ratios that can be used for analysis purposes Calculate important ratios for determining the financial performance and position of a business and explain the significance of the ratios calculated Explain the importance of gearing to a business and its owners Discuss the limitations of ratios as a tool of financial analysis © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 2 Financial ratio classification Categories Profitability Efficiency Liquidity Gearing Investment © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 3 Profitability ratios Formula Return on ordinary shareholders’ funds Net profit after taxation and preference dividend (if any) x 100 Ordinary share capital + Reserves Return on capital employed Net profit before interest and taxation x 100 Share capital + Reserves + Long-term loans Net profit margin Gross profit margin © Pearson Education Limited 2003 Net profit before interest and taxation Sales Gross profit Sales x 100 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 4 Efficiency ratios Formula Average stock turnover period Average stock held Cost of sales Average settlement period for debtors Trade debtors Credit sales Average settlement period for creditors x 365 Trade creditors x 365 Credit purchases Sales to capital employed Sales Long-term capital employed Sales per employee Sales Number of employees © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 5 The main elements comprising the ROCE ratio Net profit before interest and taxation sales multiplied by Sales Long-term capital employed equals Return on capital employed © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 6 Liquidity ratios Formula Current ratio Current assets Current liabilities (creditors due within one year) Acid test ratio Current assets (excluding stock) Current liabilities © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 7 Gearing ratios Formula Gearing ratio Long-term liabilities Share capital + Reserves + Long-term liabilities Interest cover ratio Profit before interest and taxation Interest payable © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 8 The effect of financial gearing Profit before interest and tax © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 9 Investment ratios Formula Dividend payout ratio Dividend yield ratio Dividends announced for the year x 100 Earnings for the year available for dividends Dividend per share/(1 - t) Market value per share x 100 Earnings per share Earnings available to ordinary shareholders Number of ordinary shares in issue Price/earnings ratio (P/E) Market value per share Earnings per share © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 10 Average dividend yield ratios for businesses in a range of Industries 6. 32 6 5. 15 5 4. 42 3. 35 3 Banks Real estate Electricity Food and drug retailers Leisure and hotels Transport Tobacco Engineering and machinery Chemicals Construction and building materials Oil and gas 0 3. 16 2. 85 2 1 4. 29 3. 98 3. 67 Pharmaceuticals and biotechnology 4 4. 35 4. 83 4. 52 Source: Constructed from data appearing in the Financial Times, 18 January 2003 © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 11 Average price/earnings ratios for businesses in a range of industries 30 22. 86 22. 63 16. 77 Banks Real estate 12. 67 Electricity Food and drug retailers Transport 12. 54 Pharmaceuticals and biotechnology Chemicals Oil and gas 0 Construct. and building materials 8. 45 10 12. 93 14. 06 Leisure and hotels 12. 87 Tobacco 15 5 23. 18 18. 83 18. 62 20 Engineering and machinery 25 Source: Constructed from data appearing in the Financial Times, 18 January 2003 © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition

OHT 6. 12 Graph plotting current ratio against time Current ratio XYZ Ltd Industry average 2000 2001 2002 2003 2004 Time © Pearson Education Limited 2003 Atrill, Mc. Laney: Accounting and Finance for Non-Specialists, 4 th edition