Managing Finance and Budgets

Seminar 4

Seminar Four - Activities

Preparation: readChapter 7 (M & A 2nd Edition) Or Chapter 6 (M & A 1st Edition)

Describe key concepts:Analysing accounts Ratios

Exercises: M & A (2nd Ed.) Exercise 7.3 (pages 239-240) and

Exercise 7.5 (pages 241-242) Or M & A (1st Ed.) Exercise 6.3 (pages 215-216) and

Exercise 6.5 (pages 217-218)

Starting Points

Describe what is meant by Financial Ratio Analysis, and outline the key steps in performing such an analysis.

State some of the things we need to consider when we are examining accounts, and some of the factors which might affect such our analysis.

Select and calculate

appropriate ratios

Identify users and

their information

needs

Interpret and

evaluate the results

The key steps of financial ratio analysis

Key Ratios

State the different categories of financial ratio that can be used in analysing accounts, and describe the purpose of each one.

State some of the measures within each category.

Financial ratio classification

Categories

Profitability

Efficiency

Liquidity

Gearing

Investment

Profitability

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

Efficiency

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

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

Liquidity

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

Gearing ratio

Interest cover ratio

Formula

Profit before interest and taxation_ Interest payable

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

liabilities

Gearing

The effect of financial gearing

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

Calculating and Using the Ratios (1)

What are the criteria that an investor should look for when selecting a company in which to invest?

McLaney & Atrill Exercise 7.3 (6.3 1st ed)

Dividend yield ratios Source: Financial Times 31 May 1997

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Average P/E ratios Source: Financial Times 31 May 1997

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Calculating and Using the Ratios (2)

What criteria should a supplier look for when deciding whether to supply a business customer?

McLaney & Atrill Exercise 7.5 (6.5 1st ed)

Average current ratio and average acid test ratio for 1996 for UK listed companies in various industrial sectors

Mineralextraction

0.0Generalindustrie

s

Consumergoods

Services

0.2

0.4

0.6

0.8

1.0

1.6

1.2

1.4

Utilities

Current ratio

Acid test ratio

Current ratio

Time

19X1 19X419X319X2 19X5

XYZ Ltd

Industry average

Graph plotting current ratio against time

Calculating and Using the Ratios (3)

What early-warning signs can be detected that a company may be heading towards insolvency and failure?

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

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

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

Current ratio

ROCE ratio

Failed businessesNon-failed businesses