004/5 - Financial Ratios

Average inventories' turnover period (AITP)

--> efficiency ratio Average inventories held = (Beginning of year + end of year) / 2 Measures average period for which inventories are being held · Businesses prefer short turnover periods --> Lower inventory holding costs

Average settlement period for trade receivables (ASPTR)

--> efficiency ratio Average trade receivables = (Beginning of year + end of year) / 2 Measures speed of payment, i.e. average amount of time credit customers take to pay the business Receivables = funds tied up Goal: keep receivables to a minimum

Sales revenue to capital employed (SRCE)

--> efficiency ratio Examines how effectively assets are used to generate sales revenue High ratio = assets are used productively (unless the company is overtrading on its assets)

Sales revenue per employee (SRE)

--> efficiency ratio Measures the productivity of the workforce Aim = high value for this ratio --> Shows that they deploy their staff efficiently

Average settlement period for trade payables (ASPTP)

--> efficiency ratio Ratio measures speed of payment (average amount of time comp. takes to pay its suppliers) Average trade payables = (Beginning of year + end of year) / 2 Aim = increase settlement period Stretching settlement period too far --> loss of goodwill of suppliers

Gearing ratio (GR)

--> financial gearing ratio Financial gearing = business is financed (partly) by borrowings rather than owners' equity + is a measure of risk Gearing ratio measures contribution of long-term lenders to long-term capital structure

Interest cover ratio (ICR)

--> financial gearing ratio Measures amount of operating profit available to cover interest payable Interest payable = interest expense · The lower the level of operating profit coverage, the greater the risk that lenders will not receive interest payments

Price/earnings (P/E) ratio

--> investment ratio A measure of market confidence in future of a business The higher the ratio, the... o ...greater the confidence in future earning power of the business o ...the more investors are prepared to pay in relation to current earning power

Dividend payout ratio (DPR)

--> investment ratio Measures proportion of earnings that is paid to shareholders as dividends For ordinary shares: earnings available for dividend = profit for the year less preference dividends

Dividend cover ratio (DCR)

--> investment ratio Ratio shows how often dividends can be paid by earnings for the year

Dividend yield ratio (DYR)

--> investment ratio Relates cash return from a shares to its current market value · Can help investors to assess cash return on their investment

Earnings per share (EPS)

--> investment ratio Relates earnings generated to the number of shares + Fundamental measure of share performance Earning available = net profit

Current ratio (CR)

--> liquidity ratio Compares current assets (cash or assets soon to be turned into cash) with current liabilities Manufacturing businesses = high current ratio Supermarket chains = low current ratio The higher the current ratio, the more liquid the business is Very high ratio = that excessive amounts are tied up in cash or other liquid assets (not used productively)

Acid test ratio (ATR)

--> liquidity ratio tests liquidity more strictly Inventories excluded, as many businesses cannot turn inventories into cash quickly Some companies can transform its inventories into cash very quickly (e.g. supermarkets) (In these cases inventories can be included in the ratio)

Return on capital employed (ROCE)

--> profitability ratio Compares operating profit with average long-term capital invested in a business · Average values for long-term capital employed are used (Beginning of year + end of year) / 2 · Value should be as high as possible

Return on ordinary shareholders' funds (ROSF)

--> profitability ratio Compares profit available to owners with their average investment in the business · Average of figures for ordinary shareholders' funds used (Beginning of year + end of year) / 2 · Value on this ratio should be as high as possible

Operating Profit Margin (OPM)

--> profitability ratio Measures operational performance o Supermarkets tend to have a low margin + Jewelers tend to have a high margin

Gross Profit Margin (GPM)

--> profitability ratio Measures profitability in buying and selling goods before other expenses are subtracted COGS represents a major expense for many businesses