3.6 ratio analysis topic 3– part 2. ratio analysis profitability ratios liquidity ratios financial...
TRANSCRIPT
3.6 Ratio Analysis
Topic 3– Part 2
Ratio Analysis
Profitability Ratios Liquidity Ratios Financial Efficiency Ratios Shareholder or Investment Ratios Gearing Ratio
Financial Efficiency Ratios Purpose: Measures how efficiently the
assets of a business are being used.
Stock Turnover Ratio How often the inventory is bought and sold
Debtor Days Ratio How long to collect payments from
customers who purchased goods on credit Creditor Days Ratio
How long it takes the company to pay its suppliers
Stock Turnover Ratio
Sales Revenue
Cost of Goods Sold
Current Assets
Current Liabilities
Stocks(Inventory)
AccountsRecvble
Net Profit
Gross Profit
ABC, Inc. 125 25
XYZ Corp.
2400 600
Cost of Goods Sold / Value of Stock (average for the year)
ABC Inc: 125/25 = 5
XYZ Corp: 2400/600 = 4
Which purchased inventory more frequently throughout the year?
ABC bought inventory 5 times XYZ bought inventory 4 times
Purpose: How many times do we buy our inventory in a year?
Stock Turnover Ratio Purpose: Measures how many times
inventory is purchased during the year.
The higher the number, the more efficient a company is at selling its stock so it has to buy inventory more often.
Inventory turnover rate is dependent on the industry – restaurants should have a higher turnover than a car dealership
Service sector business do not use this ratio because they do not have inventory.
Debtor Days Ratio
Sales Revenue
Cost of Goods Sold
Current Assets
Current Liabilities
Stocks(Inventory)
AccountsRecvble
Net Profit
Gross Profit
ABC, Inc. 250 75
XYZ Corp.
3200 600
Accounts Receivable / Sales Turnover (Sales)
ABC Inc: (75/250) X 365 = 109.5 days
XYZ Corp: (600/3200) X 365 = 68.62 days
Which company takes the longest time to receive money from customers?
What does this do to cash flow?
Purpose: How many days does it take for our customers to pay us?
Can also be calculated using only credit sales – eliminating cash sales – since cash sales will never lead to debtors.
Debtor Days Ratio
Purpose: Measures how long it takes to collect payments from customers who purchased goods on credit There is no right or wrong answer. Business who operate mainly in cash
will have a very low ratio. A high ratio could mean poor control
over customer payment/credit arrangements.
Creditor Days Ratio
Sales Revenue
Credit Purchases
Current Assets
AccountsPayable
Stocks(Inventory)
AccountsRecvble
Net Profit
Gross Profit
ABC, Inc. 100 20
XYZ Corp.
1125 250
Accounts Payable / Credit Purchases
ABC Inc: (20/100) X 365 = 73 days
XYZ Corp: (250/1125) X 365 = 81.395 daysWhich company takes the longest time to pay their vendors?
What does this do to cash flow?
Purpose: How many days does it take for us to pay our suppliers?
Creditor Days Ratio
Purpose: Measures how long it takes to pay vendors for goods purchased on credit There is no right or wrong answer. A high number days can reduce the
cash outflows. Vendors may be unhappy with slow
payments and discounts may be missed or not offered.
Ratio Analysis
Profitability Ratios Liquidity Ratios Financial Efficiency Ratios Shareholder or Investment
Ratios Gearing Ratio
Shareholder or Investment Ratios
Purpose: Measures the prospects of financial gain from investing.
Dividend Yield Ratio The rate of return at the current share
price Earnings Per Share Ratio
The amount each share is earning
Dividend Yield Ratio
Sales Revenue
Cost of Goods Sold
Dividends
Number of Shares
Dividends per share
Market Share Price
Net ProfitAfter Tax
Gross Profit
ABC, Inc. 21 140 .15 1.50 50
XYZ Corp.
140 200 .70 10.00 500
(Dividend Per Share / Current Share Price) X 100 (Market Share Price)
ABC Inc: .15/1.50 X 100 = 10%
XYZ Corp: .70/10.00 X 100 = 7% Which company produces more return per share?
Purpose: How much is my return on the investment at the current share price?
Dividend Per Share:
Total Dividend / Total # of Shares
ABC Inc 21 / 140 = .15
XYZ Corp 140 / 200 = .70
Dividend Yield Ratio Purpose: Measures the rate of return per
share. If share prices rise dividends are not increased, this
rate of return will fall. If share prices stay the same or fall and the
dividends are increased, this rate of return will increase.
Results need to be compared within the industry. Shareholders may be attracted to a high dividend
yield as long as stock prices do not fall. Board of Directors may choose to not pay a dividend
to keep retained profits to be reinvested back into the business.
A high dividend yield could be caused by a recent drop in stock price not profitability of the company.
Earnings Per Share Ratio
Sales Revenue
Cost of Goods Sold
Dividends
Number of Shares
Dividends per share
Market Share Price
Net ProfitAfter Tax
Gross Profit
ABC, Inc. 21 140 .15 1.50 50
XYZ Corp.
140 200 .70 10.00 500
Profit After Tax / Total Number of Shares
ABC Inc: 50/140 = .358
XYZ Corp: 500/200 = 2.50
Which company produces more earnings per share?
Purpose: How much is each share earning?
Earnings Per Share Ratio
Purpose: Measures how much is each share earning.
Allows a way to compare stocks from different companies to help evaluate investment options.
Can also be compared with the price of the share.
Ratio Analysis
Profitability Ratios Liquidity Ratios Financial Efficiency Ratios Shareholder or Investment Ratios Gearing Ratio
Gearing Ratio
Purpose: Measures the degree that capital of the business is financed by long-term loans.
Gearing Ratio The amount of long-term loans in
comparison to the total capital
Gearing RatioSales Revenue
Cost ofGoods Sold
Current Assets
Current Liabilities
Long TermLoans
*CapitalEmployed
Net Profit
Gross Profit
ABC, Inc. 40 400
XYZ Corp.
2000 5000
Long-Term Loans / Capital Employed X 100
ABC Inc: 40/400 X 100=10%
XYZ Corp: 2000/5000 X 100 = 40%
Which company is using more “borrowed” capital to operate their business?
Purpose: How much is the company relying on long-term loans vs other capital?
*capital employed = non-current liabilities + shareholders equity
A rate above 50% indicates a “highly” geared company.
Gearing Ratio Purpose: Measures the degree that capital of
the business is financed by long-term loans. The higher the ratio the greater the risk:
Heavy borrowing indicates large interest payments which will affect dividends and profits.
Debts have to be repaid and could leave the company with low liquidity.
Low gearing is a “safe” business strategy, but could indicate that management is not using borrowing as a strategy to expand the business which limits growth.
The gearing ratio can be lowered by raising cash in other ways: selling more stock, decreasing the dividend. Result: “pump up” capital without borrowing
Summary: Be careful Ratios should not be used singly but
compared with other companies in the industry or internal company records utilizing data trends over time.
Slightly different data and/or formulas can be used and reported by various companies.
Ratios only deal with financial accounting items and do not take into consideration environmental stewardship or human rights considerations.
Ratios do not solve problems or bring attention to the cause of business problems.