FINANCIAL STRATEGIES AND ACCOUNTS
“Short-term can be terminal.”
Mark McCormack
“Sometimes you have to pay a high price for an
opportunity.”
Rupert Murdoch
BUSS 3.4 Interpreting Published Accounts
INTERPRETING PUBLISHED ACCOUNTS
INTERPRETING PUBLISHED ACCOUNTS
IN THIS TOPIC YOU WILL LEARN ABOUT:

Conducting ratio analysis: the selection,
calculation and interpretation of ratios to
measure financial performance
Assessing the value and
limitations of ratio
analysis in measuring a
business’ performance
BUSS 3.4 Interpreting Published
Accounts

RATIO ANALYSIS

Allows for a more meaningful analysis of
published accounts
Shows relationship between figures
Inter and intra firm comparisons
 Ratios are used to measure the following
financial indicators:






Liquidity
Profitability
Financial Efficiency
Gearing
Shareholders
BUSS 3.4 Interpreting Published
Accounts

You will need
access to the
internet to watch
this clip
RATIO ANALYSIS - LIQUIDITY

Liquidity


Why is liquidity
crucial for survival?
A measure of a firms short term survival i.e. its ability to
meet short term debts
Liquidity
Current ratio
 Current assets : current liabilities
 Acid test
 Liquid assets : current liabilities

Liquid assets = Receivables + cash
 Inventory is not included in current assets
as it is deemed the hardest to turn into cash quickly
 The acid test ratio is a tougher measure of liquidity

Liquidity ratios
Current Ratio
Current Assets : Current Liabilities
5845 : 8160
= 0.716 : 1
For every £1 of CL the firm owes it owns
£0.716 in CA
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
Acid Test
Liquid Assets : Current Liabilities
1170 + 2300 : 8160
= 3470 : 8160
= 0.425 : 1
For every £1 of CL the firm owes it owns
£0.425 in CA
Do you think this business has enough short
term assets to meet its short term debts?
Why is the acid test a more demanding measure?
Liquid assets has been calculated as:
Receivables + Cash & cash equiv.
Explain an alternative way of calculating
liquid assets.
RATIO ANALYSIS - PROFITABILITY

Profitability

ROCE
A measure of how efficiently a business is using
capital employed to generate profits
 Capital employed = total equity + non-current
liabilities


i.e. all the money invested in the business from




Share capital
Reserves
Long term loans
Operating profit x 100
total equity + non-current liabilities
Recap AS: Profitability can also be measured by Gross and Net Profit Margins
Profitability ratio
Income Statement
Revenue
Cost of sales
Gross profit
Expenses
Operating profit
Finance income
Finance cost
Profit before tax
Taxation
Profit for the year
£m
35400
(30100)
5300
(720)
4580
300
(260)
4620
(1109)
3511
ROCE
Operating profit
x 100
total equity + non-current liabilities
4580
11235 + 6000
4580
17235
x 100
x 100 = 27%
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
For every £1 of capital employed in the business
how much is being generated in profit?
Why would it be meaningful to compare this
to the current rate of interest?
Why might a high street retailer compare
ROCE between individual stores?
RATIOS ANALYSIS – FINANCIAL EFFICIENCY
 Financial

efficiency
Asset turnover
Revenue
net assets
 Measures how efficiently the assets of the
business are being utilised to generate revenue
 Helps identify whether the business is operating
efficiently
 A capital intensive industry may have a lower
asset turnover than a labour intensive one

Financial Efficiency ratio
Income Statement
Revenue
Cost of sales
Gross profit
Expenses
Operating profit
Finance income
Finance cost
Profit before tax
Taxation
Profit for the year
£m
35400
(30100)
5300
(720)
4580
300
(260)
4620
(1109)
3511
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
Asset Turnover
Revenue
Net assets
35400
11235
=
3.15 times
For every £1 of net assets in the business
how much is being generated in revenue?
What is meant by the term sweating your assets?
Why might asset turnover help a business assess
operational efficiency between factories?
RATIOS ANALYSIS – FINANCIAL EFFICIENCY
 Financial

efficiency
Inventory (stock) turnover
Cost of sales
average inventory held
 Average inventory held can be calculated by finding the
average of inventory at the start and end of the year



You therefore also need the previous year’s balance sheet
Alternatively you can just divide cost of sales by inventory
Measures how frequently a business turns over its inventory
in a year
 Will vary depending upon the nature of the firm




Hot dog stand (hopefully daily!)
Fashion Retailer (at least each season)
New car showroom (maybe twice a year)
Financial Efficiency ratio
Income Statement
Revenue
Cost of sales
Gross profit
Expenses
Operating profit
Finance income
Finance cost
Profit before tax
Taxation
Profit for the year
£m
35400
(30100)
5300
(720)
4580
300
(260)
4620
(1109)
3511
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
Inventory Turnover
Cost of sales
Inventory
On average for how long does this business
hold stock?
30100
2375
=
12.67 times
What type of business might have this level of
inventory turnover? Justify your answer
Why might it be more accurate to divide by average
inventory held rather than just inventory?
RATIOS ANALYSIS – FINANCIAL
EFFICIENCY
 Financial

efficiency
Payables (creditors) days
Payables
x 365
cost of goods sold
 A measure of how long it takes on average for the
business to pay for supplies it has purchased on
credit
 A business may try to have a longer payables day
to ease cash flow problems
 A short payables day may result in discounts from
suppliers

In December 2008 300 non-food suppliers were told by Tesco that they would be increasing payment terms,
which would mean they would only pay their suppliers within 60 days, instead of 30.
To what extent do you think this is a strategy to improve Tesco’s cash flow situation?
Analyse the possible reasons why Tesco can take such action.
Financial Efficiency ratio
Income Statement
Revenue
Cost of sales
Gross profit
Expenses
Operating profit
Finance income
Finance cost
Profit before tax
Taxation
Profit for the year
£m
35400
(30100)
5300
(720)
4580
300
(260)
4620
(1109)
3511
Payables (Creditors) days
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
Payables x 365
cost of goods sold
Payables is not shown as a separate figure on this balance sheet.
I am therefore going to assume it is 50% of current liabilities.
In an examination a figure would be given
4080 x 365
30100
=
49 days
Assume payables is the only current
liability, how would this alter the
payables days?
Why might a business be willing to have
a payables days of 60 – 90 days?
RATIOS ANALYSIS – FINANCIAL
EFFICIENCY
 Financial

efficiency
Receivables (debtors) days
Receivables x 365
revenue
 A measure of how long it takes on average for
customers to pay the business for products or
services it has purchased on credit
 The customer is a debtor of the business
 A business may try to have a shorter receivables
day to ease cash flow problems

Financial Efficiency ratio
Income Statement
Revenue
Cost of sales
Gross profit
Expenses
Operating profit
Finance income
Finance cost
Profit before tax
Taxation
Profit for the year
£m
35400
(30100)
5300
(720)
4580
300
(260)
4620
(1109)
3511
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
Receivables (Debtors) days
Receivables x 365
Revenue
1170 x 365
35400
=
12 days
Payables are compared to cost of sales and
receivables to revenue.
Use Business Studies terminology to explain the
relationship between these variables.
What might be the expected receivables days of
a) A high street coffee chain
b) A commercial print company
Justify your answers.
RATIO ANALYSIS - GEARING
 Gearing

Gearing (%)
Non-current liabilities
x 100
total equity plus non-current liabilities
 Measures what proportion of a business’ capital is funded
through long term loans
 Loans are “compulsory interest bearing”


You have to pay interest on them even if profits are low or
non-existent
Explain how this is different to equity capital

A high gearing is of greater risk if interest rates are likely to
increase

Interest rates are a cost to a business
Explain where interest rates would appear on an income statement
and which profit figure(s) would be affected.
Gearing ratio
Income Statement
Revenue
Cost of sales
Gross profit
Expenses
Operating profit
Finance income
Finance cost
Profit before tax
Taxation
Profit for the year
£m
35400
(30100)
5300
(720)
4580
300
(260)
4620
(1109)
3511
Gearing
Balance Sheet
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities
Net current liabilities
Non-current liabilities
Net assets
£m
19550
2375
1170
2300
5845
(8160)
(2315)
(6000)
11235
Share capital
Reserves & retained earnings
Total equity
6000
5235
11235
Non-Current Liabilities x 100
total equity + non-current liabilities
6000
(11235 + 6000)
=
6000 x 100
17235
=
35%
x 100
For every £1000 invested in this business how
much of it is from long term loans?
Why might a high gearing be more of a concern to
a business with small profit margins?
RATIO ANALYSIS - SHAREHOLDERS
You will need access to
the internet to watch this
clip
 Shareholder

Dividend per share (in pence)
Total dividends
number of issued ordinary shares
 The return paid to shareholders’ for their investment
 Money paid in dividends reduces retained profit
 Will be influenced by financial objectives

If a dividend of £600m was paid out to a total of 750m shareholders
the dividend per share would be:
£600m / 750m = 0.80p
For every 1 share owned the shareholder would receive 80p in dividends
RATIO ANALYSIS - SHAREHOLDERS
 Shareholder

Dividend yield

o
o
o
Ordinary share dividend (in pence) x 100
current market price (in pence)
Measures the return on the investment as a percentage of
current market price
Market price fluctuates on a regular (constant basis)
Allows for a more accurate comparison of the value of the
shareholders’ investment compared to other investment
opportunities
If dividend per share is 80p and the current market share price £15
the dividend yield is:
0.80 / 15.00 x 100 = 5.3%
Do you consider this to be a good return?
How does this compare to savings accounts, ISAs, other share options?
Value and Limitations of Ratio Analysis

Value
 Provides a tool for the
interpretation of
accounts
 Structure from which
comparisons can be made
 Aids decision making
 Internally
 Externally by
investors

Limitation
 Possibility that accounts
have been window dressed
 Need to consider reasons
behind ratios
 E.g. is ROCE lower
than previous year
because of an
investment programme
 Quantitative information
only
Activity – Interpreting published
accounts
In pairs choose 2 businesses who operate in the
same industry e.g. 2 supermarkets, 2 football clubs
 Go onto the internet and print off their Balance
Sheet and Income Statement (Google company
name/investors)
 The layout will vary from company to company but
you should be able to identify the key information
 Prepare a presentation comparing the performance
of the two businesses
 Present your findings to the rest of the class
