Financial Ratio Analysis

Gross Profit Margin

(Gross Profit / Sales Revenue) x 100

How efficiently a company produces and sells its goods

The higher the gross profit margin, the more money a company retains from each dollar of sales

Operating Profit Margin

(Operating Profit (PBIT) / Sales Revenue) x 100

How efficiently a company manages its core business operations

An indicator of operational profitability

Return on Equity (ROE)

Profit before tax / Shareholder’s Equity

How effectively a company is using both equity and debt to produce profits

Return on ordinary shareholders’ funds (ROSE)

(Net profit / Ordinary share capital + Reserves) x 100

How effectively a company uses the money invested by its shareholders to generate profits

Return on capital employed (ROCE)

(Operating profit (PBIT) / Share capital + Reserves + Non-current liabilities) x 100

Current Ratio

Current Assets / Current Liabilities

Measures a company’s abilitiy to pay off its short-term liabilities with its short-term assets

Quick (acid test) ratio

(Current Assets - Inventory) / Current Liabilities

A more stringent measure of liquidity used as some businesses would struggle to convert inventory into cash

Non-current asset turnover ratio

Revenue / Non-current assets

How efficiently a company uses its non-current (long-term) assets to generate revenue

Average inventory

(Opening + closing inventory) / 2

Inventory Turnover in days

(Average inventory / Cost of Sales) x 365

The average numbers of days it takes for a company to sell its inventory

Trade receivables in days

(Trade receivables / revenue) x 365

Trade payables in days

(Trade payables / COGS) x 365

Sales revenue per employee

Sales revenue / number of employees

Gearing

Debt / Equity

A high level of gearing means company must pay out relatively high interest

Interest is paid out of profits - high interest means less profit to distribute to shareholders

So highly geard companies are riskier for shareholders

Interest Cover

Profit before interest and tax / Interest

Dividend Payout Ratio

(Dividends announced for the year / Earnings for the year available for dividends) x 100

Measures proportion of earnings that a business pays out to shareholders in the form of dividends

Dividend Cover Ratio

Earnings for the year available for dividends / Dividends announced for the year

Dividend Yield Ratio

(Dividends per share / Market value per share) x 100

Relates cash return from a share to its current market value

Earnings per share

Earnings available to ordinary shareholders / number of ordinary shares in issue

Calculates how much profit has been made on a ‘per share’ basis

Price/earning (P/E) ratio

Market value per share / earnings per share

A high P/E ratio suggests the market expects earnings growth or has more confidence in the firm