Financial ratio analysis, exercise and worksheet

Financial ratio analysis Is the process of collecting, calculating, analysing and interpreting results from the accounts of companies and organisations. A financial ratio is a relationship between two or more financial values which can be expressed in a number of ways, e.g. percentage, times, number of weeks. It is important 1. To apply agreed rules regarding the specification of the various components of any ratio in a consistent manner. 2. To interpret changes in the resulting ratios against previous levels, industry averages or simple benchmarks.

A basic analysis of financial ratios usually cover the following: Profitability: to assess the return on the capital employed by a company. Liquidity: to assess a company's ability to pay its way in the short-term; to meet its financial obligations. Gearing: measures the relationship between interest bearing debt and equity (or shareholder's fund).

Using the analysis framework above, the following ratios can be calculated: Profitability:

Profit as a percentage of Capital employed

Profit as a percentage of Revenues

Revenues divided by Capital employed Liquidity:

Current assets divided by Current liabilities

Liquid assets divided by Current liabilities

Cost of sales divided by Inventories

Trade receivables divided by average weekly revenues Gearing:

Total Borrowings divided by Equity Interest Payable as a percentage of (Profit before Tax + Interest Payable)

Financial ratio analysis Example

Income statement for the year ended: 2011 2010

000 000

(D) REVENUES 5,500 4,700

(Q) Cost of sales 2,850 3,000

Distribution costs 1,800 900

Administrative expenses 600 600

(B) Interest Payable 140 150

(A) PROFIT BEFORE TAXATION 110 50

Taxation -40 -20

PROFIT ATTRIBUTABLE TO SHAREHOLDERS 70 30

Dividend -20 -20

RETAINED PROFIT 50 10

Balance Sheet as at 31st March 000 000

NON-CURRENT ASSETS 400 300

CURRENT ASSETS (O)

Inventories 950 1,100

(P) Trade and other receivables 500 600

Cash and cash equivalent 50 100

(L) 1,500 1,800

CURRENT LIABILITIES

Trade and other payables 425 600

(I) Bank overdraft 675 660

Taxation 0 20

Dividend 0 20

(M) 1,100 1,300

NET WORKING CAPITAL 400 500

(E) TOTAL ASSETS LESS CURRENT LIABILITIES 800 800

EQUITY

(F) Issued share capital 130 130

(G) Retained earnings 550 500

680 630

(J) LONG-TERM LOAN 120 170

800 800

Financial ratio analysis worksheet - Profitability and Gearing

Where to look

P R O F I T A B I L I T Y

(A) Profit before taxation IS

(B) Interest payable IS

(C) Profit before tax + interest payable A+B

(D) Revenues IS

(E) Net capital employed (1) BS

1.1 PROFIT NET CAPITAL EMPLOYED %

1.2 PROFIT REVENUES %

1.3 REVENUES NET CAPITAL EMPLOYED

G E A R I N G

(F) Issued share capital BS

(G) Retained earnings BS

(H) Equity (or shareholders fund) F+G

(I) Bank overdraft BS

(J) Long-term loans BS

(K) Total borrowings I+J

3.1 TOTAL BORROWINGS EQUITY

3.2 INTEREST PAYABLE PROFIT BEFORE TAX + INTEREST %

(1) Net capital employed = Non-current assets + Current assets - Current liabilities

Financial ratio analysis worksheet - Working capital

Where to look

W O R K I N G C A P I T A L

(L) Current assets BS

(M) Current liabilities BS

(N) Liquid assets (1) BS

2.1 CURRENT ASSETS CURRENT LIABILITIES

2.2 LIQUID ASSETS CURRENT LIABILITIES

(O) Inventories BS

(P) Trade and other payables BS

(Q) Cost of sales IS

(R) Average weekly revenues (2) IS

2.3 COST OF SALES INVENTORIES

2.4 TRADE RECEIVABLES AVERAGE WEEKLY REVENUES

(1) Liquid assets = Current assets - Inventories

(2) Average weekly revenues = Revenues divided by number of weeks in period