Ratio analysis

LIQUIDITY RATIO:

Current assets
a) Current Ratio=  X :1
Current liability

 Sufficient current assets to cover current liabilities?

 General standard is 2:1. In excess of 2:1 indicates over-investment in working capital.

Current assets - Inventory

b) Quick / Acid test Ratio=  X :1
Current liability

 Inventory is excluded from the ratio because inventory is not a very liquid current
asset.
 Some manufacturing companies hold large quantities of raw material stocks.
Finished goods might be warehoused for a long time, or sold on lengthy credit. In
such businesses stocks are not very liquid assets.
 If Current ratio is higher than Quick ratio, it means working capital is tied up in
inventory. If quick ratio is comparatively very low, it indicates a lot of working capital
tied up in stock and may encounter cash flow problems.
 General standard is 1:1. In excess of 1:1 indicates over-investment in working capital.

Liquidity ration: Current ratio and Quick ratio are below industry average:
 Poor level of liquidity.
 Utilizing liquid resources to finance fixed investments?
 Utilizing liquid resources to repay past borrowings?
 Industry growing too fast ignoring liquidity?
 Improve liquidity through disposing surplus assets and/or reducing stock level and/or
speeding up debtors’ collection period and/or slowing payments to creditors.

PROFITABILITY RATIO:

a) Profit Before Interest & Tax (PBIT) =

Profit before taxation + Interest charges on long-term loan capital

b) Capital Employed = Total asset - Current liability

Or, = Share capital + Reserves + Long-term liability

PBIT
c) Return On Capital Employed (ROCE) =  100%  X%
Capital Employed
 This ratio indicates how efficiently a business is using the funds available (equity and
long-term debt). It measures how much is earned per $1 invested.
 It is thus a measures of the efficiency and effectiveness with which the managers
have made use of the resources available to them.

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 Ratio analysis

 ROCE uses profit which is not directly linked to the objective of maximizing
shareholders wealth.
 If increase from previous year or above industry average: good sign and reflects the
fact that the company has managed to increase sales without a proportionate
increase in costs.
 If decrease from previous year or below industry average: problem with control of
costs. Level of dividend has also fallen.

Profit after tax & preferred Dividend

d) Return on equity (ROE) =  100%  X %
Ordinary share capital & reserve

 Indicates to ordinary shareholders how well their investments has performed

 Measures how much profit a company generates for its ordinary shareholders with
the money they have invested in the company.

Profitability ratio: ROCE and ROE are above industry average:

 Favorable condition.
 Non-current assets ever not been revalued? Revaluation could depress these ratios.

Turnover ( Sales )
e) Asset turnover ratio =  X :1
Capital employed

 This shows the turnover that is generated from each $1 worth of asset employed.
The higher the turnover per $1 invested the more efficient use of the assets
employed.

Nrt profit
f) Net profit margin = 100%  X %
Sales
 Higher percentage indicates: costs are being controlled; sales prices are high
compared to costs

Gross profit
g) Gross profit percentage = 100%  X %
Sales

 High: Effective purchasing strategy. Concentrating on low volume, high margin sales
 Low: selling its products cheaply in order to generate more sales.

Operating profit
h) Operating profit percentage = 100% 100%
Sales

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 Ratio analysis

EFFICIENCY RATIO:

Trade Receivable s
a) Receivables Collection Period=  365 days  XX days
Credit sales

 An approximate measure of the length of time it takes for a company’s customers to

pay what they owe.
 Receivables collection period similar with payables payment period represent better
credit control policy.
 Normally Receivables Collection Period is less than 30 days. Significantly in excess
of this might be representative of poor management of funds of a business. However,
some companies such as exporting companies must allow generous credit terms to
win customers.
 If the collection period is increasing year on year, this might show a poorly managed
credit control function, and an increased risk of bad debts.
 However, increase in receivables collection period might be a deliberate policy to
increase sales by offering better credit terms than competitors. Adversely affect the
cash flow position if early payment and late receipts happen.

Avg. Inventory
b) Stock / Inventory Turnover Period=  365 days  XX days
Cost of Sales
Cost of sales
Or, =  X times
Avg. inventory
Trade Payable
c) Payable Payment Period=  365 days  XX days
Credit Purchase

 Less than 30 days: sufficient cash to pay its payables promptly.

 More than 30 days: indicate that may have liquidity problem.

INVESTMENT RATIO:

a) Earnings Per Share (EPS) =

Profit after interest,tax and preferencedividend
 X$
Number of ordinary shares
Market price of share
Or,  X$
Pr ice earnings ratio

 A key measure of company performance from an ordinary shareholder’s point

of view.
 Shows the amount of profit attributable to each ordinary share.
 Increase in EPS generally indicates success.
 Both right issue and bonus issue result in a fall of EPS. So, care must be
taken when interpreting.
 Decrease in EPS will not be welcomed.
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 Ratio analysis

 EPS does not represent actual income of the shareholder. Rather, it

represents the investor’s share of profit after tax.

Total ordinary dividend Announced

b) Dividend Per Share (DPS)= X$
Total number of ordinary share
DPS
c) Dividend payout ratio =  100%
EPS

Earnings / profit after tax and preference dividend

c) Dividend Cover=  X times
Ordinary dividend

Market price per ordinary shareshare

d) Price Earnings (P/E) Ratio= X
EPS

 Basic measure of a company’s performance from the market’s point of view.

 P/E ratio expresses the amount of money shareholders are prepared to pay
for the share as a multiple of current earnings.
 It expresses the current share price as a multiple of the most recent EPS.
 Higher P/E ratio indicates possible better performance of the company in the
future, may be rise in profit.

Dividend per share

e) Dividend Yield= 100%  X %
Market price per share
f) Share Price = P/E X EPS

DEBT & GEARING RATIOS:

Total debts
a) Debt / Equity Ratio= *100%  X %
Total assets

Loans  Preferred shares

b) Gearing ratio = *100%  X %
Ordinary shares  All reserves

Shareholde rs' equity

c) Leverage=
Shareholde rs' quity  total long term debt

Shareholde rs' quity

Or, =
Total assets - current liabilitie s

PBIT
d) Interest Cover =  X times
Interest charges

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 Ratio analysis

T 10
Raw material
a) Raw material stock turnover / holding period = * 365
Cost of purchase

Avg. profit or return

b) Accounting rate of return = *100%  X %
Avg. investment

Accumulate d profit  Accumulate d depreciati on

c) Avg. return =
Life of the project

Initial investment  Scrap value

d) Avg. investment =
2

F9: FM:
Long term debt  Pr eference share capital
Financial gearing = X 100%
Ordinary share capital and reserves
Long term debt  Pr eference share capital
= X 100%
Share capital  Re serves  Long term debt
Pr ofit before int erest
= X 100%
Pr ofit after int erest
Fixed cos ts
Operational gearing = X 100%
Total cos ts
Fixed cos ts
= X 100%
Variable cos ts
Contributi on
= X 100%
PBIT

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