Ratio analysis

• Until now only concerned with the preparation of

financial statements, now need to look at what they tell
us.

• Conclusions need to be drawn so that decisions can be

made.

• The accounts are analysed using financial indicators/

ratios

• Ratios are no good on their own- they don’t really tell us

anything unless they are compared with something.

Comparatives that can be used

• Previous years
• Budgets
• Similar business
• ‘trade’indicators

• The ratios calculated depend on who is looking at the

accounts and what they are most interested in, e.g

User type of ratio

Management profitability
Lenders liquidity
Investor investor

Types of ratio
• Profitability
• Short term liquidity
• Medium/long term liquidity
• Efficiency
• Investor/ shareholder
Profitability

Gross profit percentage

= gross profit *100

sales

Net profit percentage

= net profit *100

sales

Return on capital employed

(roce)

= profit before interest & tax *100

Share capital+reserves+long term liabilities

Short term liquidity

Current ratio

=current assets
current liabilities

Liquidity/ quick ratio

=current assets-stock
current liabilities
Efficiency

Stock turnover

=cost of sales
average stock

Average stock
= opening +closing stock
2

If both stock figures not available, use closing stock

Debtor days

=debtors *365
sales

Creditor days

= creditors *365
purchases
More complex ratios

Calculations
• Return on equity

Roe= profit after tax & pref div

osc +reserves

Asset turnover= turnover

Fixed assets

Debt/equity ratio= interest bearing net debts

shareholders funds
Or

Gearing ratio = prior charge capital

total capital

Interest cover = pbit

interest payable

Dividend cover= profit after tax & pref div

div on ordinary shares

Dividend yield= dividend per share

Market value per share

P/e ratio= mid market price

eps

Eps = profits attributable to ordinary shares

number of ordinary shares
Notes
I) liquidity
• Though a company can generate liquid assets from
sources other than sales , generally liquidity does
depend on making sales & profits
• But , profits don’t always lead to increases in liquidity-
could use funds to buy assets or pay divs etc

Ii )debt & gearing

• Gearing is an attempt to quantify the degree of risk in
owning shares in a co
• If highly geared lot of profit is earmarked for those with
a prior charge on profits, and less available for ordinary
s’holders
• Dividends likely to be more volatile
• Higher chance of security being called in (doesn’t need
much fluctuation in pbit for such a co to have severe
problems paying interest)
• Only those co’s with suitable, long term, high-value
assets can ‘afford’ to be highly geared e.g property co

Iii )investment ratios

• If the company is listed , need to consider current
price as well as values in the accounts
• P/e ratio- the higher the better because it reflects the
confidence of the market
• Earnings yield allows comparison of companies with
different dividend policies showing growth rather than
earnings
Limitations

• Availability of comparable information

• Use of historical/ out of date information
• Ratios are not definitive; are only a guide
• Interpretation needs careful analysis , should not be
considered in isolation
• It is a subjective exercise
• Subject to manipulation
• Ratios not defined in standard form
Ratio questions

1. Z Ltd is a small, privately owned company. The profit &

loss accounts and balance sheets for the past 2 years are
summarised below

Z Ltd, profit & loss account for the year ended 31 March
2008
31.3.09 31.3.08
£000 £000 £000 £000
Sales 1,000 900
Opening stock 50 40
Purchases 700 650
Closing stock (80) 670 (50) 640
Gross profit 330 260

Depreciation 32 32
Other expenses 118 88
150 120
Net profit 180 140
Tax 90 70
90 70
Dividends 85 68
Retained profit for the 5 2
year
P&L b/f 18 16
P&L c/f 23 18

Balance sheets
31.3.09 31.3.08
£000 £000 £000 £000
Tangible fixed assets 258 290
Current assets
Stock 80 50
Debtors 90 60
Bank 8 20
178 130
Creditors:< 1 yr 128 117
308 303
Capital & Reserves
Ordinary Share 285 285
capital (£1)
P&L account 23 18
308 303

Prepare a report commenting on the performance of Z

ltd.B Ltd
2.The following are the summarised accounts for B Ltd:

Balance sheets
30.9.08 30.9.09
£000 £000 £000 £000
Tangible fixed 4,995 12,700
assets

Current assets
Stock 40,125 50,455
Debtors 40,210 43,370
Bank 12,092 5,790
92,447 99,615
Creditors:< 1 yr
Trade creditors 32,604 37,230
Tax 2,473 3,260
Proposed dividend 1,785 1,985
(36,862) (42,475)
Net current assets 55,585 42,475

Total assets less 60,580 69,840

current liabilities

Creditors: > 1yr

Debentures (19840) (19,840)
40,780 50,000
Capital & Reserves
Ordinary Share 9,920 9,920
capital (25p)
P&L account 30,820 40,080
40,740 50,000
Profit & Loss accounts

30.9.08 30.9.09
£000 £000
Turnover 486,300 583,900
Cost of sales 469,062 563,230
Gross profit 17,238 20,670
Interest payable 1,984 1,984
Profit before tax 15,254 18,686
Tax 5,734 7,026
Profit after tax 9,520 11,660
dividends 2,240 2,400
Profit for the year 7,280 9,260
Profit b/f 23,540 30,820
Profit c/f 30,820 40,080

You are required to calculate relevant ratios and comment

on the performance of B Ltd
3. RST Plc
The following are the summarised accounts for XYZ Ltd;
RST Plc is considering purchasing XYZ and you are
required to write a report to the directors of RST Plc
commenting on the financial position of XYZ Ltd and
highlighting any areas that require further investigation

XYZ Ltd: Balance sheet as at 31 December

31.12.2008 31.12.09
£000 £000 £000 £000
Tangible fixed assets
Land & buildings 12,121 11,081
Plant & machinery 9,020 9,130
21,141 20,211
Current assets
Stock 2,663 3,995
Debtors 2,260 3,164
Cash 53 55
4,976 7,214
Creditors:< 1 yr
Trade creditors 388 446
Bank 2,300 3,400
Tax 1,420 1,195
Proposed dividend 1,696 1,800
5,804 6,841
Net current assets (828) 373
Creditors: > 1yr
Debentures (5,000) (5,000)
15,313 15,584
Capital & Reserves
Ordinary Share capital 8,000 8,000
(£1)
P&L account 7,313 7,584
15,313 15,584
Profit & Loss account for the year ended 31 December

31.12.08 31.12.09
£000 £000
Turnover 18,900 19,845
Cost of sales 10,340 11,890
Gross profit 8,560 7,955
Distribution costs 1,670 1,405
Administrative expenses 1,503 1,591
Operating profit 5,387 4,959
Interest payable on 215 450
overdraft
Debenture interest 600 600
Profit before tax 4,572 3,909
Tax 2,000 1,863
Profit after tax 2,572 2,071
dividends 1,693 1,800
Profit for the year 879 271
4.Hanson Ltd

The following information relates to Hanson Ltd

Balance sheets
30.6.09 30.6.08
£000 £000 £000 £000
Tangible fixed assets
Land & buildings 500 450
Plant & equipment 450 500
950 950
Current assets
Stock 63.5 60
Debtors 42.5 41
Bank 40 55
146 156
Creditors:< 1 yr
Trade creditors 49.6 49.3
Tax 1.5 1.7
Accruals 5.2 4.3
Proposed dividend 30 25
86.3 80.3

Creditors: > 1yr 200 200

809.7 825.7
Capital & Reserves
Ordinary Share 600 600
capital (£1)
Share premium 125 125
P&L account 84.7 100.7
809.7 825.7
Profit & Loss accounts

30.6.09 30.6.08
£000 £000
Turnover 1,000 900
Cost of sales 600 550
Gross profit 400 350
Selling & admin expenses 270 255
Interest payable 30 20
Profit before tax 100 75
Tax 50 37.5
Profit after tax 50 37.5
dividends 30 25
Profit for the year 20 12.5

You are required to calculate relevant ratios and comment

on the performance of Hanson Ltd
5. The following are the summarised accounts for Fry Ltd.
Laurie Plc is considering purchasing Fry Ltd and you are
required to write a report to the MD of Laurie Plc
commenting on the financial position of Fry Ltd and
highlighting five areas that require further investigation

Profit & Loss account for the year ended 31 December

31.12.08 31.12.07
£000 £000
Turnover 913 981
Cost of sales 590 645
Gross profit 323 336
Distribution & Admin costs 219 214
Operating profit 104 122
Interest payable 19 15
Profit before tax 85 107
Tax 45 52
Profit after tax 40 55
Dividends- ordinary 14 14
- preference 10 10
Profit for the year 16 31
Fry Ltd: Balance sheet as at 31 December
31.12.08 31.12.07
£000 £000 £000 £000
Tangible fixed assets 264 246

Current assets
Stock 294 303
Debtors 160 141
Bank 52 58
506 502
Creditors:< 1 yr
Trade creditors 75 75
Other creditors 111 105
186 180
Net current assets 320 322
Creditors: > 1yr
Debentures 138 138
446 430
Capital & Reserves
Ordinary Share capital 100 100
(50p)
£1 10% preference 100 100
shares
P&L account 246 230
446 430
6. The following are the summarised accounts for Black
Ltd. You are required to write a report to the MD of Black
Ltd commenting on the financial performance of the
company.

Black Ltd: Balance sheet as at 31 September

30.9.09 30.9.08
£ £ £ £
Tangible fixed assets 34,995 22,700

Current assets
Stock 40,125 20,455
Debtors 40,210 23,370
Bank 2,092 15,790
82,447 59,615
Creditors:< 1 yr
Trade creditors 32,604 47,230
Tax 2,473 3,260
Dividend 1,785 1,985
36,862 52,475
Total assets less 80,580 29,840
current liabilities
Creditors: > 1yr
Debentures 50,000 10,000
30,580 19,840
Capital & Reserves
Ordinary Share capital 10,000 10,000
(25p)
£1 10% preference 10,000 -
shares
P&L account 10,580 9,840
30,580 19,840
Profit & Loss account for the year ended 30 September

30.9.09 30.9.08
£ £
Turnover 389,500 302,200
Cost of sales 375,000 291,100
Gross profit 14,500 11,100
Distribution & Admin costs 7,400 7,200
Operating profit 7,100 3,900
Interest payable 2,600 600
Profit before tax 4,500 3,300
Tax 2,000 1,800
Profit after tax 2,500 1,400
Dividends- ordinary 760 800
- preference 1,000 -
Profit for the year 740 600