Part 7: Chapter 47An introduction to the analysis and

interpretation of accounting statement

By: Nenae 11gs

What are ratios use for?

o To compare business whether which are getting more profit

Who are interest in these ratio?

o Shareholderso Lenderso Customerso Supplierso Employeeso Governmento Competitors

Categories of ratio

o Profitability ratioso Liquidity ratioso Efficiency ratioso Shareholder ratioso Capital structure ratioso Other ratios

Profitability ratios (as percentage)

1. Return on capital employed (ROCE) = net profit x 100

capital employed

This show how successful managers are at earning a profit from capital used in the business. For every $ invested, the business make …% extra.

2. Gross profit margin = gross profit x 100

sales

This show how much gross profit is made for every $ earned. For every $ make from sales, …% kept as gross profit margin.

3. Net profit margin = net profit x 100

sales

This show how much net profit is made for every $ earned. For every $ make from sales, …% is kept as net profit margin.

Liquidity ratios

1. Current ratio = current assets

current liabilities

This show how many times a business can pay its short term debts.

2. Acid ratio test = current assets – stock

current liabilities

Similar to current ratio, however without stock because some business may find it difficult to sell stock quickly.

Efficiency ratios1. Inventory turnover (times) = cost of sales

average inventory

This measure how efficient a business is at maintaining an appropriate level of inventory.

2. Accounts receivable/ sales ratio = 1: …

then translate into length of time a debtor takes to pay: 365 x 1 = …days

…

3. Accounts payable/purchases ratio = 1: …

then translate into length of time we take to pay out creditors: 365 x 1 = …days

…

Shareholder ratios1. Earnings per share (EPS) = net profit after interest and tax and preference dividends

number of ordinary shares issued

This gives the shareholder a chance to compare one year’s earnings with another in terms easily understood.

2. Price/earnings ratio (P/E) = Marketing price per share

earnings per share

The greater the P/E ratio, the greater demand for the shared.

3. Dividend yield = Gross dividend per share

market price per share

This measure the real rate of return by comparing the dividend paid to the market price of a share.

4. Dividend cover = net after tax and preference dividends

ordinary dividends paid and proposed

This gives the shareholder some idea as to the proportional that the ordinary dividends bear to the amount available for distribution to ordinary shareholders. If the dividend is to be 3 times covered, this means that one-third of the available profits is being distributed as dividends

Capital structure ratios

-Gearing = long term loans + preference shares x 100ordinary share capital + reserves + preference shares + long term liabilities

Or in shorter formula Prior charge capital x 100

total capital

Other ratios

1. Operating profit/loan interest

2. Total external liabilities/shareholders’ funds

3. Shareholders’ funds/total assets

Fixed and variable costs

Fixed costs are the cost which remain constant. This do not matter whether the activity increase or decrease.

Variable costs are the cost that change due to the increase or decrease of the activity

Questions….

?

Income Statement $ $Sales 555,000Less: COGSOpening inventory 100,000Add: Purchases 200,000

300,000Less: closing inventory (60,000)

(240,000)gross profit 315,000Less: depreciation 5,000wages, salaries, commission 165,000other expenses 45,000 (215,000)Net profit 100,000Statement of financial positionnon-current assetequipment at cost 50,000less: depreciation to date (40,000) 10,000current assetinventory 60,000a/c receivable 125,000bank 25,000 210,000total assets 220,000current liabilitiesa/c payable (104,000)net assets 116,000

financed by:-capitalbalance at start of year 76,000add: net profit 100,000

176,000less: drawing (60,000)total capital 116,000

Calculate:1a). Rate of return of net profit on capital employed (average of capital)1b). Gross profit margin1c). Net profit margin1d). Inventory turnover1e). Current ratio1f). Acid test ratio1g). a/c receivable/sales ratio1h). a/c payable/purchases ratio1a). 100,000/(76,000+116,000/2) = 104.2%1b). 315,000/555,000x100 = 56.8%1c). 100,000/555,000x100 = 18%1d). 240,000/(100,000+60,000/2) = 3 times1e). 210,000/104,000 = 2.02 : 11f). (210000-60000)/104,000 = 1.44 : 11g). 125,000/555,000x12 = 2.7 months1h). 104,000/200,000x12 = 6.24 months

Calculate:

2a). Earnings per share

2b). Price/earnings ratio

2c). Dividend yield

2d). Dividend cover

3). If prior charge capital = 30,000 and total capital = 210,000, what is the gearing?

oNet profit after interest and tax and preference dividends = $300,000oNumber of ordinary share issued = $500,000oMarket price per share = $4.20oGross divided per share = $20oInterest = $10,000oOrdinary dividends paid and proposed = $120,000

2a). 300,000/50,000 = 602b). 4.20/0.6 = 72c). 0.20/4.20 = 4.76%2d). 300,000 + 10,000/120,000 = 2.58 times3).30,000/210,000 = 14.3%