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Financial ratio classification

Categories

Profitability

Efficiency

Liquidity

Gearing

Investment

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Select and calculate

appropriate ratios

Identify users and

their information

needs

Interpret and

evaluate the results

The key steps of financial ratio analysis

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Profitability ratios

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

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Efficiency ratios

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

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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

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Liquidity ratios

Current ratio

Acid test ratio

Operating cash flows to maturing obligations

Formula

Current assets_______________ Current liabilities (creditors due within one

year)

Operating cash flows Current liabilities

Current assets (excluding stock) Current liabilities

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Average current ratio and average acid test ratio for UK listed companies in various industrial sectors

Source: Datastream data, February 2001

Current ratio

Acid test ratio

Chemicals0.0

Electricity Food and drugs retailers

Food producers

0.2

0.4

0.6

0.8

1.0

1.6

1.2

1.4

Household goods and

textiles

2.0

1.8

Information Technology Hardware

Water

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Gearing ratios

Gearing ratio

Interest cover ratio

Formula

Profit before interest and taxation_ Interest payable

Long-term liabilities _______ Share capital + Reserves + Long-term

liabilities

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The effect of financial gearing

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Investment ratios

Dividend per share

Dividend payout ratio

Dividend yield ratio

Earnings per share

Formula

Dividends announced during the period Number of shares in issue

Operating cash flow per share

Dividends announced for the year x 100 Earnings for the year available for dividends

Dividend per share/(1-t) x 100 Market value per share

Price/earnings ratio (P/E)

Earnings available to ordinary shareholders Number of ordinary shares in issue

Operating cash flows – preference dividends Number of ordinary shares in issue

Market value per share Earnings per share

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Average dividend yield ratios

0

1

2

6

5

4

3

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2.53

3.79 3.77

5.82

1.54

5.35

2.85

1.95

2.22

4.19

6.62

2.84

Source: Constructed from information in Financial Times, 8 December 2000

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Average P/E ratios

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25

30

35

20

15

10

5

40

13.91 10.2

1

13.38

8.53

11.60

17.93

26.84

22.51

12.11 9.89

16.83

41.50

Source: Constructed from information in Financial Times, 8 December 2000

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Current ratio

Time

1997 200019991998 2001

XYZ Ltd

Industry average

Graph plotting current ratio against time

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Mean ratios of failed and non-failed businesses

+0.35

+0.45

+0.25

+0.15

+0.05

-0.15

-0.05

+0.1

-0.1

-0.2

0.78

0.79

0.65

0.58

0.51

0.37

0.44

0.0

1 2 3 4 5 2 3 4 51 1 2 3 4 5

Cash flow Total debt

Net income Total assets

Total debt Total assets

Non-failed firms Failed firms

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Mean ratios of failed and non-failed businesses

0.36

0.42

0.30

0.24

0.18

0.06

0.12

3.5

2.5

2.0

+0.15

+0.05

-0.05

-0.15

3.0

1 2 3 4 5 2 3 4 51 1 2 3 4 5

Working capital Total assets

Current ratio

No credit interval

Non-failed firms Failed firms

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Scatter diagram showing the distribution of failed and non-failed businesses

Current ratio

ROCE ratio

Non-failed businessesFailed businesses