IBM Ch Past CH2

Ratio Analysis

Quantitative managmeent tool comparing financial figures to judge a firm’s financial performance

What Does Ratio Analysis Require

Applying figures of the final accounts: balance sheet and profit + loss account

How to assess if financial performance improved

Comparing current figures with historical figures and/or comparing to rival businesses

Purposes of ratio analysis

• Examine a financial position

• Assess financial performance

• Compare real figures against projected/budgeted figures

• Aid decision making

Historical Comparisons

Comparing the same ratio of two different time periods, showing trends and financial performance over time

Inter-Firm Comparisons

Comparin teh same ratios of different businesses in the same industry, showing their relative financial performance

When financial ratios are used

Only with rivals in of similar size in the same industry

Types Of Profability Ratios

• Gross profit margin

• Profit margin

• Return on capital employed (ROCE)

Profability Ratios

Profit in relation to other figures i.e. revenue, sales, equity

Profit

Financial surplus earnings of a firm after costs have been deducted

Limtation of profitability ratios

Only applies to profit-orientated businesses

Gross Profit Margin

Firm’s gross profit as a percentage of its revenue

ways to raise sales revenue

• ↓ selling price of products (w/ many substitutes)

• ↑ selling price of products (w/ few substitutes or loyal customers)

• ↑ marketing strategies

• Alternative revenue streams

ways to reduce direct costs

• ↓ direct material costs; cheaper suppliers/materials

  • May ↓ brand rep

• ↓ direct labour costs; ↓ staff, flexitime

Profit Margin

Percentage of sales turnover turned into profit

Sales Turnover (Revenue)

Total sales over a given period (financial year)

PM vs GPM

Profit margin covers both cost of sales (direct cost) and expenses (indirect cost) while GPM does not = better measurement of profitability

Relationship between