Analysing the Annual Statements - Financial Ratios

This set of vocabulary flashcards covers key financial ratios including solvency, profitability, and income margins as presented in the lecture notes on annual statement analysis.

Solvency

The degree to which the total assets of a business cover its total liabilities, representing the ability to pay all debts even if business activities stopped.

Debt ratio

The extent to which the total assets of a business are financed by total liabilities, calculated using the formula: $\frac{\text{Total liabilities}}{\text{Total assets}} \times 100$.

Financial Risk and Debt Ratio

The principle that the higher the debt ratio, the higher the financial risk of the business; conversely, a lower ratio indicates lower risk.

Interest coverage ratio

Indicates the number of times the business can pay the interest commitment for the year from its income before interest and tax, calculated as: $\frac{\text{Income before interest and tax}}{\text{Interest paid}}$.

IBIT

An acronym for Income Before Interest and Taxation.

Profitability

Used to determine the success or failure of a business by displaying how profitably the available capital has been employed in business activities.

Profitability of the business (ROA)

The return the business earns on capital invested, calculated as: $\frac{\text{Net income before interest and tax}}{\text{Total assets}} \times 100$.

ROA Evaluation Benchmarks

Guidelines stating ROA should at least exceed the inflation rate, be higher than alternative investments, and definitely be higher than interest rates.

Profitability of own capital (ROE)

An indication of the return the owners have earned on their capital annually, calculated as: $\frac{\text{Net income after interest and before tax}}{\text{Total equity (Own Capital)}} \times 100$.

IBT

An acronym for Income Before Taxation, also described as net income after interest and before tax.

Gross income margin

Expresses the gross income as a percentage of the total sales of the year, calculated as: $\frac{\text{Gross income}}{\text{Total sales}} \times 100$.

Market Trends and Gross Income Margin

A margin that is too high relative to the market can suggest higher prices than competitors (risking a decline in sales) or better purchasing prices (lower cost of sales).

Net income margin

Expresses the net income before tax as a percentage of total sales, showing the percentage realized for every $R1$ of sales: $\frac{\text{Net income after interest and before tax}}{\text{Total sales}} \times 100$.

Factors Favourably Influencing Net Income Margin

Lower operating costs, higher sales, higher selling prices, and more favourable purchase prices (lower cost of sales).

Liquidity Ratios

A group of financial ratios that includes the Current ratio and the Acid-test ratio.

Activity Ratios

A group of financial ratios including Inventory (stock) turnover, Debtors collection period, and Creditors payment period.