Accounting Ratios

Profitability Ratios

return on capital employed, return on equity, operating profit margin, asset turnover, gross profit margin, expenses to sales

Return on Capital Employed (ROCE)

Operating Profit (PBIT) / (Equity + Non-current Liabilities) * 100%

Return on Equity / Return on shareholders funds

Profit after Tax / Equity * 100%

Operating Profit Margin

Operating Profit (PBIT) / Sales * 100%

Asset Turnover

Sales / Capital Employed (Denominator of ROCE)

Gross Profit Margin

Gross Profit / Sales * 100%

Expenses to Sales

Expenses / Sales * 100%

Liquidity Ratios

Current Ratio, Acid Test Ratio (Quick Ratio)

Liquidity Ratios

concerned with business’ ability to meet current (short term) liabilities as they due

Current Ratio

Current Assets / Current Liabilities : 1

Results Meaning of Current Ratio

“#’ : 1 → for £1 they owe, they have # amount to pay it off

Results of Current Ratio

2:1 considered good; higher figure may not be good as it may indicate too high levels of inventory, trade receivables, & cash

Acid Test Ratio (Quick Ratio)

(Current Assets — Inventories) / Current Liabilities : 1

Acid Test Ratio

Measures availability of liquid resources (excludes inventory because least liquid current asset) to meet current liabilities

Results of Acid Test Ratio

< 1:1 → company does not have enough liquid short term assets

Efficiency (WC) Ratios

Inventory Days, Trade Receivable Days, Trade Payable Days

Efficiency Ratios

For working capital management

Inventory Days

days on average stock is held before sold

Inventory Days

Inventory / Cost of Sales * 365 days

Trade Receivable Days

days on average trade receivables are paid back to us

Trade Receivable Days

Trade Receivables / Credit Sales (use net sales if no CS) * 365 days

Trade Payable Days

days on average it takes for us to pay trade payables

Trade Payable Days

Trade Payables / Credit Purchases (use cost of sales if no CP) * 365 days

Results of Trade Payable Days

30 to 60 days

Ideal Ratio between TP Days and TR Days (positive cash)

Trade Payable Days > Trade Receivable Days

Working Capital Cycle

Inventory Days + Trade Receivable Days — Trade Payable Days

Gearing Ratio

Non-current Liabilities / (Equity + Non-current Liabilities) * 100%

Use of Gearing Ratio

measures level of debt finance (fixed interest) compared to equity in a business

Low Gearing

< 20%

Moderate Gearing

20-50%

High Gearing

> 50%

Impacts of Gearing

High gearing = high volatility of return to equity holders

Additional borrowing difficult for highly geared companies

Interest Cover

Operating Profit (PBIT) / Interest Expense

Interest Cover

measures how many times the operating profit covers the interest expense, how safe a level of borrowing is

Low Interest Cover

greater risk of not meeting interest payments

Earnings per Share (EPS)

Earnings (PBIT) / # of ordinary shares in issue

Price to Earnings (P/E)

Price per Share (Market Price) / EPS