Managing Finance and Budgets
Seminar 4
Seminar Four - Activities


Preparation: read
Chapter 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.
The key steps of financial ratio analysis
Identify
users and
their
information
needs
Select and
calculate
appropriate
ratios
Interpret
and
evaluate the
results
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
Formula
Return on ordinary
shareholders’ funds
Net profit after taxation and preference dividend (if any) x 100
Ordinary share capital + Reserves
Return on capital
employed
Net profit before interest and taxation
x 100
Share capital + Reserves + Long-term loans
Net profit margin
Net profit before interest and taxation
Sales
Gross profit margin
Gross profit
Sales Sales
x 100
x 100
Efficiency
Formula
Average stock
turnover period
Average settlement
period for debtors
Average settlement
period for creditors
Average stock held
Cost of sales
Trade debtors
Credit sales
x 365
x 365
Trade creditors x 365
Credit purchases
Sales to capital
employed
_______ Sales__________
Long-term capital employed
Sales per employee
_______Sales_______
Number of employees
The main elements comprising the ROCE ratio
Net profit before
interest and taxation
sales
multiplied by
Sales______
Long-term capital
employed
equals
Return on capital
employed
Liquidity
Formula
Current ratio
Acid test ratio
Operating cash flows
to maturing
obligations
Current assets_______________
Current liabilities (creditors due within one year)
Current assets (excluding stock)
Current liabilities
Operating cash flows
Current liabilities
Gearing
Formula
Gearing ratio
Interest cover
ratio
Long-term liabilities
_______
Share capital + Reserves + Long-term liabilities
Profit before interest and taxation_
Interest payable
The effect of financial gearing
Investment ratios
Formula
Dividend per share
Dividend payout
ratio
Dividend yield ratio
Earnings per share
Operating cash flow
per share
Price/earnings ratio
(P/E)
Dividends announced during the period
Number of shares in issue
Dividends announced for the year x 100
Earnings for the year available for dividends
Dividend per share/(1-t)
Market value per share
x 100
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)
1
0
Retail banks
Water
Electricity
Food retailers
Media
Distribution
Tobacco
Pharmaceuticals
Engineering
Chemicals
Building and
construction
Oil exploration
and production
Dividend yield ratios
Source: Financial Times 31 May 1997
6
5
4
3
2
10
5
0
Retail banks
Water
Electricity
Food retailers
Media
Distribution
Tobacco
Pharmaceuticals
Engineering
Chemicals
Building and
construction
Oil exploration
and production
Average P/E ratios
Source: Financial Times 31 May 1997
40
35
30
25
20
15
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
Current ratio
1.6
Acid test ratio
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
Mineral
extraction
General
industries
Consumer
goods
Services
Utilities
Graph plotting current ratio against time
Current
ratio
XYZ Ltd
Industry
average
19X1
19X2
19X3
19X4
19X5
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
Failed firms
Non-failed firms
Cash flow
Total debt
Net income
Total assets
Total debt
Total assets
0.79
+0.1
+0.45
0.78
+0.35
0.0
+0.25
0.65
0.58
+0.15
0.51
-0.1
+0.05
0.44
-0.05
0.37
-0.2
-0.15
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5
Mean ratios of failed and non-failed businesses
Failed firms
Non-failed firms
Working capital
Total assets
Current
ratio
0.42
No credit
interval
3.5
+0.15
3.0
+0.05
2.5
-0.05
2.0
-0.15
0.36
0.30
0.24
0.18
0.12
0.06
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5
Scatter diagram showing the distribution of
failed and non-failed businesses
Failed businesses
Non-failed businesses
Current
ratio
ROCE ratio