Part 7: Chapter 47 An introduction to the analysis and interpretation of accounting statement

1. Part 7: Chapter 47An introduction to the analysis and interpretation of accounting statement By: Nenae 11gs

2. What are ratios use for? • To compare business whether which are getting more profit

3. Who are interest in these ratio? • Shareholders • Lenders • Customers • Suppliers • Employees • Government • Competitors

4. Categories of ratio • Profitability ratios • Liquidity ratios • Efficiency ratios • Shareholder ratios • Capital structure ratios • Other ratios

5. Profitability ratios (as percentage) 1. Return on capital employed (ROCE) = net profit x 100 capital employed This show how successful managers are at earning a profit from capital used in the business. For every $ invested, the business make …% extra. 2. Gross profit margin = gross profit x 100 sales This show how much gross profit is made for every $ earned. For every $ make from sales, …% kept as gross profit margin. 3. Net profit margin = net profit x 100 sales This show how much net profit is made for every $ earned. For every $ make from sales, …% is kept as net profit margin. z

6. Liquidity ratios 1. Current ratio = current assets current liabilities This show how many times a business can pay its short term debts. 2. Acid ratio test = current assets – stock current liabilities Similar to current ratio, however without stock because some business may find it difficult to sell stock quickly.

7. Efficiency ratios 1. Inventory turnover (times) = cost of sales average inventory This measure how efficient a business is at maintaining an appropriate level of inventory. 2. Accounts receivable/ sales ratio = 1: … then translate into length of time a debtor takes to pay: 365 x 1 = …days … 3. Accounts payable/purchases ratio = 1: … then translate into length of time we take to pay out creditors: 365 x 1 = …days …

8. Shareholder ratios 1. Earnings per share (EPS) = net profit after interest and tax and preference dividends number of ordinary shares issued This gives the shareholder a chance to compare one year’s earnings with another in terms easily understood. 2. Price/earnings ratio (P/E) = Marketing price per share earnings per share The greater the P/E ratio, the greater demand for the shared. 3. Dividend yield = Gross dividend per share market price per share This measure the real rate of return by comparing the dividend paid to the market price of a share. 4. Dividend cover = net profit after tax and preference dividends ordinary dividends paid and proposed This gives the shareholder some idea as to the proportional that the ordinary dividends bear to the amount available for distribution to ordinary shareholders. If the dividend is to be 3 times covered, this means that one-third of the available profits is being distributed as dividends

9. Capital structure ratios -Gearing = long term loans + preference shares x 100 ordinary share capital + reserves + preference shares + long term liabilities Or in shorter formula Prior charge capital x 100 total capital

10. Other ratios 1. Operating profit/loan interest 2. Total external liabilities/shareholders’ funds 3. Shareholders’ funds/total assets

11. Fixed and variable costs Fixed costs are the cost which remain constant. This do not matter whether the activity increase or decrease. Variable costs are the cost that change due to the increase or decrease of the activity

12. Questions….?

13. Calculate: 1a). Rate of return of net profit on capital employed (average of capital) 1b). Gross profit margin 1c). Net profit margin 1d). Inventory turnover 1e). Current ratio 1f). Acid test ratio 1g). a/c receivable/sales ratio 1h). a/c payable/purchases ratio 1a). 100,000/(76,000+116,000/2) = 104.2% 1b). 315,000/555,000x100 = 56.8% 1c). 100,000/555,000x100 = 18% 1d). 240,000/(100,000+60,000/2) = 3 times 1e). 210,000/104,000 = 2.02 : 1 1f). (210000-60000)/104,000 = 1.44 : 1 1g). 125,000/555,000x12 = 2.7 months 1h). 104,000/200,000x12 = 6.24 months

14. Net profit after interest and tax and preference dividends = $300,000 • Number of ordinary share issued = $500,000 • Market price per share = $4.20 • Gross divided per share = $20 • Interest = $10,000 • Ordinary dividends paid and proposed = $120,000 Calculate: 2a). Earnings per share 2b). Price/earnings ratio 2c). Dividend yield 2d). Dividend cover 3). If prior charge capital = 30,000 and total capital = 210,000, what is the gearing? 2a). 300,000/50,000 = 60 2b). 4.20/0.6 = 7 2c). 0.20/4.20 = 4.76% 2d). 300,000 + 10,000/120,000 = 2.58 times 3).30,000/210,000 = 14.3%