Lecture 5 - Financial Ratios (analyzing and interpreting financial statements)

Define current ratio and give its formula

Current ratio compares the "LIQUID" ASSETS (that is cash, inventory and trade recievables - assets turned into cash easily) of the business with the CURRENT LIABILITIES. CURRENT RATIO = CURRENT ASSETS/CURRENT LIABILITIES

Define financial ratios

A financial ratio or accounting ratio is a RELATIONSHIP between two selected values taken from a firms financial statements. There are many STANDARD RATIOS used to try to evaluate the OVERALL FINANCIAL CONDITION of a corporation or other organization. Used for COMPARISON PURPOSES. >>

What is the problem with average settlement period for trade payables ratio?

Like the average settlment period for trade recievables ratio, the average SETTLEMENT PERIOD can be DISTORTED for one or two large suppliers.

Outline the "Investment" ratio category What do they show?

Ratios used by EXTERNAL USER GROUPS, often (potential) investors. Certain ratios are concerned with assesing the RETURNS and PERFORMANCE OF SHARES in a particular business from the PERSPECTIVE of SHAREHOLDERS who are not involved with the management with the business.

Define sales revenue per employee ratio and give its formula

Relates SALES REVENUE generated during a reporting period to a particular business RESOURCE - LABOR. >> Provides a measure of productivit og the workforce. Sales revenue per employee = sales revenue/number of employees

What are the strengths and limitations of using financial ratios?

STRENGTHS - Help identify what QUESTIONS to ask. - Help to highlight the finanacial STRENGTHS AND WEAKNESSES of a business. WEAKNESSES - Do not provide ANSWERS to the questions asked. - Cannot explain why the STRENGTHS and WEAKNESSES exist or why certain CHANGES have occured. *** RATIOS PROVIDE A STARTING POINT FOR FURTHER ANALYSIS. ONLY DETAILED INVESTIGATION WILL REVEAL THE UNDERLYING REASONS.

When are averages used in financial ratios?

- Averages are used for ratios when they combine a figure for a PERIOD (such as profit for the year), with one taken at A POINT IN TIME (such as shareholder´s funds).

How can a business reduce its OCC?

- REDUCE average inventories turnover period - REDUCE average settlement period for trade recivebles - INCREASE average settlement period for trade payables

How are financial ratios generally grouped?

- Ratios can be grouped into CATEGORIES, with each CATEGORY relating to a PARTICULAR ASPECT of FINANCIAL PERFORMANCE or position. - Each group of categories portray a different aspect/area of the bussiness.

Dicuss comparison of ratios comparing planned performance to realized performance? How is it done? What are the limitations?

- Ratios may be compared with targets that management developed before the start of the period under review. - A measurement of ACHIEVEMENT ATTAINED. > Provides most VALUABLE BENCHMARK AGAINST whihch MANAGERS may assess their own business. - Planned/target ratios may be prepared for each aspect of the businesses activity. PROBLEMS: 1. Planned performance must be based on realistic assumptions (based on past performance and performance of other businesses)

What does the set of financial ratios used by an analyst depend on?

- The analyst must be clear of WHO the target users are and WHY they need the information. - Different users of financial information are likely to have different information needs.

Is there an accepted list of ratios? Is there a standard method for calculating ratious? What implications does this have?

- There is NO generally accepted list of ratios - Nor is there a STANDARD METHOD for calculating many of the ratios. VARIATION will exist in both the set of ratios chosen and how they are calculated. >>> Therefore important, to be CONSISTENT in the way in which ratios are calculated for COMPARISON PURPOSES (e.g only use year end values, or only use averages etc.)

Outline the "Financial gearing" ratio category What do they show?

- This is the relationship between the CONTRIBUTION TO FINANCIAL OF THE BUSINESS made by the OWNERS and the contribution made by OTHERS, in the form of LOANS. - This is important because it has an important efect on the LEVEL OF RISK ASSOSCIATED WITH THE BUSINESS. - Gearing ratios help to reveal the extent to which LOAN FINANCE is utillised and the consequent effect on the level of RISK borne by a business. GEARING => LOAN FINANCE --> RISK

Show how the ROCE ratio for Alexis plc can be analysed into the two elements for each of the years 2009 and 2010. What conclusions can you draw from your figures? Roce 2009 = 34.7% Roce 2010= 5.9%

.Although the business was more effective at generating sales revenue (sales revenue to capital employed ratio increased) in 2010 than in 2009, in 2010 it fell well below the level necessary to compensate for the sharp decline in the effectiveness of each sale (operating profit margin). As a result, the 2010 ROCE was well below the 2009 value.

What are the 2 components of ROCE?

1. Controlling costs to increase operating profit 2. Using assets effectively to generate sales

What information can be derived from the statment of financial position of ALexis given?

1. EXPANSION OF NON-CURRENT ASSETS - These have increased by about 15 per cent (from £510 million to £587 million). Note 7 mentions a new warehouse and distribution centre, which may account for much of the additional investment in non-current assets. We are not told WHEN this new facility was established, but it is quite possible that it was well into the year. This could mean that not much benefit was reflected in terms of additional sales revenue or cost saving during 2010. Sales revenue, in fact, expanded by about 20 per cent (from £2,240 million to £2,681 million); this is greater than the expansion in non-current assets. MAJOR EXPANSION IN THE ELEMENTS OF WORKING CAPITAL - Inventories increased by about 35 per cent, trade receivables by about 14 per cent and trade payables by about 36 per cent between 2009 and 2010. These are major increases, particularly in inventories and payables (which are linked because the inventories are all bought on credit - see Note 2).

List the ratios that fall under the proftiability category (thos used to evaluate profitability of the business). There are 4.

1. Operating profit margin 2. Gross profit margin 3. Returns on capital employed (ROCE) 4. Return on ordinary shareholders´funds (ROSF) AKA Return on Equity (ROE)

What are the 3 bases to which you can compare a financial value of a business in a ratio?

1. Past period for the same business 2. Similar businesses for the same or past periods 3. Planned performance for the business.

List the 5 broad categories of financial ratios.

1. Profitability 2. Efficiency 3. Liquidity 4. Financial gearing 5. Investment PE LIF(e)

Outline the "profitability" raio category What do they show?

- Businesses generally exist with the primary PURPOSE OF CREATING WEALTH FOR OWNERS (maximizing profits). - Porfitability ratious provide some INDICATION OF THE DEGREE OF SUCCESS IN ACHIEVING THIS PURPOSE. - They normally express the profit made in relation to other KEY FIGURES in the financial statements or to some BUSINESS RESOURCE.

Dicuss comparison of ratios between current and past periods? How is it done? What are the limitations?

- By comparing a calculated ratio to the same ratio for a previous period it is possible to detect whether there has been an IMPROVEMENT or DETERIOATION IN PERFORMANCE PROBLEMS: 1. possibility that trading conditions were different in compared periods. 2. Operating efficiencies may not be clearly exposed: e.g. the fact that sales revenue per employee increasd by 10% over the previous period, may be misleading if competitors have increased by 50%. 3. INFLATION: may have distored figures on which the figures are based. >> Leads to overstatment of (Current) profit and understatment of (historic bought) assets.

What is the importance of ROCE and why?

- Condisered by many to be a PRIMARY MEASURE OF PROFITABILITY. - COMPARES INPUTS (capital invested) with outputs (operating profit) so as to reveal the EFFECTIVENESS with which FUNDS HAVE BEEN DEPLOED.

What is a good (high or low) sales revenue per employee ratio?

- Generally businesses would prefer a high value for this ratio, implyming they are DEPLOYING THEIR STAFF EFFICIENTLY.

Dicuss comparison of ratios between similar businesses? How is it done? What are the limitations?

- In a COMPETITIVE ENVIRONMENT, a business must compare its performance to competitors. >> SURVIVAL may be dependent on abilitiy to reach similar levels of performance. PROBLEMS: 1. Comeptitors have DIFFERENT YEAR ENDS and so the TRADING CONDITIONS may not be the same (influencing the ratio) 2. DIFFERENT ACCOUNTING POLICIES, which can have sig. effect on reported profits and asset values (e.g. diff. methods of calculating depreciation or valuing inventories 3. FINANCIAL INFORMATION MAY NOT BE PUBLICED: >> Sole properitariships and partnerships are not obliged to make financial statmetns public. >> Large diverse limited companies may not provide a breakdown of activities in sufficient detail to enable comparisons.

What ratio categories are generally used by long-term lenders?

- Interested in long-term viability of the business, and to asses this use PROFITABILITY and GEARING RATIOS.

How many ratios exist? How many are used?

- It is POSSIBLE to CALCULATE A LARGE NUMBER OF RATIOUS, only a FEW based on KEY RELATIONSHIPS tend to be USEFUL to the user. >> Ratios are ONLY useful when there is a MEANINGFUL RELATIONSHIP between the two items.

If a company has taken on a lot of new employees why might the sales revenue to employee ratio still be low?

- New workers were inefficient - Workers WERE HIRED LATE IN THE YEAR

In what ways can financial ratios be expressed?

- Percentage - Porportion Dending on the needs of the user group.

What are financial ratios used for? Why are they needed?

- Provie a QUICK & RELATIVELY SIMPLE means of assesing the financial health of a business. - Helpful when comparing (BENCHMARKING= the financial health of different business. >> DIFFERENCES IN SCALE OF OPERATIONS exists between firms, as a result DIRECT COMPARISON of financial values would be MISLEADING. By expressing values in terms of ratios the PROBLEM OF SCALE IS ELIMINATED. RATIOS can be COMPARED DIRECTLY.

Calculate the average settlement period for trde payables for Alexia for the year ended 31 March 2015? Given that the trade payables for year ending march 2014 was 183, and the credit purchases was 1804

= (average trade payables/credit purchases) x 365 = (183+261)/2)/1804 x 365 = 44.9 days. This means that it takes on AVERAGE 44.9 days between buyig goods/services on credit and paying for them with cash.

Define average settlement period for trade payables ratio and give its equation

= (average trade payables/credit purchases) x 365 Where credit purchases equals inventory bought on credit. The average settlement period for trade payables ratio measure how long, on AVERAGE, the business takes to pay those who have supplied goods and services on credit. ****IF YOU ARE NOT GIVEN CREDIT PURCHASES USE COST OF GOODS - MUST BE CONSISTENT.

What is considered a good average inventory turnover period?

A business will normally prefer a SHORT INVENTORIES TURNOVER period to a long one, ebcause holding inventory has COSTS, for example the opportunity cost of the funds tied up.

Can you have a low operating profit margin, and a low sales revenue, but still have a high operating profit margin?

A relatively high sales revenue to capital employed ratio can compensate for a relatively low operating profit margin. Similarly, a relatively low sales revenue to capital employed ratio can be overcome by a relatively high operating profit margin. In many areas of retail and distribution (for example, supermarkets and delivery services), the operating profit margins are quite low but the ROCE can be high, provided that the assets are used productively (that is, low margin, high turnover).

Calculate the acid test for Alexis as at 31 march 2015

Acid test ratio = current assets (excluding inventories)/ current liabilities. = 544-300 / 292 = 0.8 times (0.8:1). *** In this case, the "liquid" curren assets do not quite cover the curreny liabilities, so the business may be experiencing some LIQUIDITY PROBLEMS.

Outline the "efficiency" ratio category What do they show?

Aka ACTIVITY RATIOS. Ratios may be used to measure the EFFICIENCY with which particular RESOURCES, such as INVENTORIES or EMPLOYEES, have been used within the business.

What do you deduce from the liquidity ratios of Alexia as given?

Although it is not possible to make a totally valid judgement without knowing the PLANNED RATIOS, there appears to have been a worrying decline in liquidity. This is indicated by all three of these ratios. The most worrying is in the last ratio because it shows that the ability of the business to generate cash from trading operations has declined, relative to the short-term debts, from 2009 to 2010. The apparent liquidity problem may, however, be planned, short-term and linked to the expansion in non-current assets and staffing. It may be that when the benefits of the expansion come on stream, liquidity will improve. On the other hand, short-term claimants may become anxious when they see signs of weak liquidity. This anxiety may lead them to press for payment, which could cause problems for Alexis plc.

What is the OCC for the tope 1000 european business (excluding financial and auto manufacturing businesses)

Around 40% And is declinging slightly.

Why is gross profit margin important?

As cost of sales (accounted for in the gross profit term) represents a major expense for many businesses, a change in this ratio can have a significant effect on the "bottom line" (that is profit of the year).

What is a "good" average settlment period for trade payables? / What do businesses prefer?

As trade payables provide a FREE SOURCE of FINANCE for the business, it is not suprising that some businesses attempt to increase their average settlement period for trade payables (increases their own CASH POSITION) Such a policy can be taken TOO FAR, HOWEVER, and can result in a LOSS OF GOODWILL OF SUPPLIERS.

What is the average inventories turnover period for Alexia in 2009, given that the inventories held in 2008 totalled 241 and the cost of sales is 1,745?

Average inventories turnover period = (average inventories held/cost of sales) x 365 Average inventories turnover period = ((241+300)/2)/1745) x 365 = 56.6 days This means that on average the inventories held are being turned over every 56.6 days. >> So a carpet bought by the business on a particular day would on average have been sold about eight weeks later.

What is the average settlement period for trade recievables for Alexandria for year 2009, given that the trade recievables for 2008 were 223?

Average settlement period for trade recievables =((223+240)2)/2240)x365 = 37.7 days

What is the current ratio for Alexis as at 31 march 2009?

CURRENT RATIO = CURRENT ASSETS/CURRENT LIABILITIES = 544/(261+30) = 1.9 times (or 1.9:1)

Give an example of an industry where operating profit margin differs widely between competitors

Car industry (also retail) - BMW = target opearting profit margin of 8 to 10% - Toyota = target operating profit margin of 5% - Renault = target operating profit margin of 6%

Do businesses want a high or low ROSF (ROE)?

Companies seek to maximize profits on behalf of the investors. Therefore a HIGH ROE/ROSF is desired.

Define cash generated from operation to maturing obligations ratio and give its formula

Compare the CASH GENERATED from OPERATIONS (taken from the statement of cash flows) with the CURRENT LIABILTIES of the business. IT provides a FURTHER INDICATION of the abilitiy of the business to meet its maturing obligations. Cash generated from operations to maturing obligations ratio = Cash generated from operations / current liabilities

Discuss the apparent debt capacity of Alexis

Comparing the non-current assets with the long-term borrowings implies that the business may well be able to offer security on further borrowing. This is because potential lenders usually look at the value of assets that can be offered as security when assessing loan requests. Lenders seem particularly attracted to land and, to a lesser extent, buildings as security. For example, at 31 March 2010, noncurrent assets had a carrying amount (the value at which they appeared in the statement of financial position) of £587 million, but long-term borrowing was only £300 million (though there was also an overdraft of £76 million). Carrying amounts are not normally, of course, market values. On the other hand, land and buildings tend to have a market value higher than their value as shown on the statement of financial position due to inflation in property values.

Which basis of comparisons are used for internal and external user groups of a business?

EXTERNAL: - Past performance to current performance - Performance compared to competitors ^^The only information available to external groups INTERNAL: - Expected performance to compared performance >> Only available to managers. MOST VALUABLE indicator for managers to ASSESS THEIR OWN BUSINESS.

What are efficiency ratios used for? List them.

Efficiency ratios are used to try to asses how succesfully the various resources of the business are managed. 1. Average inventories turnover period 2. Average settlement period for trade recievables 3. Average settlement period for trade payables 4. Sales revenue to capital employed 5. Sales revenue per employee

Define overtading When does this happen?

Engage in more business than can be supported by the market or by the funds or RESOURCES AVAIALBLE Happens: when the sales revenue to long-term capital is excessivly high.

Visually represent the OCC in comparison to inventories turnover period

FIGURE depicts the position for a WHOLESALING business Payment for inventories acquired on credit occurs some time after those inventories have been purchased and, therefore, no immediate cash outflow arises from the purchase. Similarly, cash receipts from credit customers will occur some time after the sale is made. There will, therefore, be no immediate cash inflow as a result of the sale. The OCC is the time period between the payment made to the supplier for goods and the cash received from the credit customer.

What does the operating profit margin of an industry depend on? Give an example of an industry with a high operating margin and a low operating margin.

Factors such as the DEGREE of COMPETITION, the TYPE OF CUSTOMER, the ECONOMIC CLIMATE and INDUSTRY CHARACTERISTICS (such as the level of risk) will influence the operating profit margin. SUPERMARKETS: tend to operate on low prices and therefore low operating profit margins. This is done in an attempt to stimulate sales and thereby increase the total amount of operating profit generated. JEWELLERS on the other hand tend to have high operating profit margins but much lower levels of sales volume.

What is a good sales revenu to capital ratio (high or low)?

Generally, a higher sales revenue to capital employed ratio is preferred to a lower one. >> This suggests that the assets are being used more effeciently in the production of revenue. HOWEVER, A VERY high ratio may suggest that the business is "over-tadfin" on its assets. AKA the business has INSUFFICIENT ASSETS to SUSTAIN the LEVEL of SALES REVENUE achieved.

What does a good/high ROE/ROSF come from?

Good Return OnEquity comes from GOOD OPERATIONS (2 components):  1. Using ASSETS EFFICIENTLY to generates sales 2. CONTROLLING COSTS to generate profit. That process is reflected in Return On Capital Employed...ROCE

Calculate the gross profit margin for Alexis for the year to 31 march 2016

Gross product margin = (gross profit / sales revenu)x100 = (409/2681)x100 = 15.3%

Define gross profit

Gross profit = sales revenue - cost of sales (or cost of goods sold)

When is a low average settlement period for trade recievables bad?

If the low average settlement period was achieved at the expense of CUSTOMER GOODWILL or through high out-of-pocket cost (e.g. giving large discounts for prompt payments).

Define average settlement period for trade recievables and give the equation

Indicates how long, on average, credit customers take to pay the amounts that they owe to the business. Average settlement period for trade recievables =(Avg. trade recievables/credit sales revenue)x365

Outline the "liquidity" ratio category What do they show?

It is VITAL to the SURVIVAL of a business that there are SUFFICIENT LIQUID RESOURCES available to meet maturing obligations (that is, amounts owing that must be paid in the near future). >> Without liquidity the company RISKS BANKRUPTCY (or has to go looking for additional funding, either stock or bank loan, which is EXPENSIVE). Liquidity ratios examine the RELATIONSHIP between LIQUID RESOURCES, or CASH generated, and amount due for payment in the near future (e.g. current assets vs. CURRENT LIABILITIES).

What are the limitations assosciated with the average settlement period for trade recievables?

It produces the AVERAGE figure for the number of days for which debts are outstandiing. The average may be BADLY DISTORED by, for example, a few large customers who are very slow or very fast payers.

What is a the IDEAL current ratio? Give examples.

It seems to be believed by some that there is an "IDEAL" current ratio (usually 2 times or 2:1) for all businesses. HOWEVER, this is NOT the case. DIFFERENT TYPES OF BUSINESSES REQUIRE DIFFERENT CURRENT RATIOS. EXAMPLES: 1. MATURING BUSINESS: will normally have a relativly high current ratio because it will hold inventories of fiished goods, raw materials and work in progress. It will also sell on credit, giving rise to trade recievables. 2. SUPER MARKET:will have a relativly low ratio, as it will hold only fast-moving consumer inventories of finished goods and its sales will be for cash rather than on credit.

What are liquidity ratios concerned with? List the 3 most common types.

Liquidity ratios are concerned with the ability of the business to MEET ITS SHORT-TERM FINANCIAL OBLIATIONS. The following ratios are widely used: ● current ratio ● acid test ratio ● operating cash flows to maturing obligations

Discuss the lower opearting profit of Alexis

Lower operating profit. Though sales revenue expanded by 20 per cent between 2009 and 2010, both cost of sales and operating expenses rose by a greater percentage, leaving both gross profit and, particularly, operating profit massively reduced. The level of staffing, which increased by about 33 per cent (from 13,995 to 18,623 employees - see Note 6), may have greatly affected the operating expenses. (Without knowing when the additional employees were recruited during 2010, we cannot be sure of the effect on operating expenses.) Increasing staffing by 33 per cent must put an enormous strain on management, at least in the short term. It is not surprising, therefore that 2010 was not successful for the business.

Are ratios only used for comparison between businesses?

No. Ratios are useful for comparing businesses, and esp. BENCHMARKING in the industry. But Ratios can also be used to when COMPARING THE PERFORMANCE of the same business from one time period to another. >> From a small number of ratios, it is often posisble to build up a revealing picture of the POSITION and PERFORMANCE of a business.

Where is cash generated from operations found? Calculate the Cash generated from operations to maturing obligations ratio for Alexis for the year ended 31 march 2009. Given that current liabilities = 291.

On the cash balance. = Cash generated from operations/current liabilities = 251/291

Calculate the operating profit margin for Alexis plc for the year ended 31 march

Operating Profit Margin = (Operating profit / Sales revenue) x 100 = (243/2240)x100 = 10.8% This means that for every 1 pound of revenue, 10,8 p (10.8% of a pound) was left as operating expenses.

Calculate the ROSF (ROE) for Alexis, given the income statement and that the total equity stood at 438 M pounds at 1 April 2014.

Profit available to ordinary shareholders = 165 Odrinary shareholders equity =(438+563)/2 Therefore ROSF = 165 /((438+563)/2) *100 = 33% * The average of ordianry shareholders equity (as at the BEGINNING and at the END of the year) has been used. This is because the AVERAGE figure is usually more REPRESENTATIVE.

Define bottom line

Profit for the year

Define ROSF (ROE) and provide its formula.

RETURN ON SHAREHOLDERS FUNDS = it essentially measures how much profit shareholders can expect per pound invested in the company (they invest X, and profit Y is generated) The return on ordinary shareholders' funds ratio compares the PROFIT AVAILABLE TO ORDINARY SHAREHOLDERS (that is profit from previous period - any preference dividend) to the ODRINARY SHAREHOLDERS EQUITY in the firm (that is ordinary capital + reserves/profits = amount of profit attrituble to owners) ROSF = (Profit avaiable to ordinary shareholders/Ordinary shareholders equity) X 100 Use the average of the ordinary shareholders equity when possible as this is more ACCURATE >> Because the shareholder equity does NOT remain CONSTANT through out the financial period.

What ratio shoes the that overall return on funds employed within a business is determined by both profitability of sales and efficienty of capital? Why?

ROCE By breaking down the ROCE ratio in this manner, we highlight the fact that the OVERALL RETURN ON FUNDS EMPLOYED within the business will be determined BOTH PROFITABILITY of SALES AND BY EFFICIENCY IN THE USE OF CAPITAL.

Calculate ROCE for Alexis. Given from notes: At 1 April 2008, the total of equity stood at £438 million and the total of equity and non-current liabilities stood at £638 million.

ROCE = 243/ ((638 + 763)/2) x 100 = 34.7% 763 = Odinary shares+ reatined earninging + non-current liabilities = 300 + 263+ 200 = 763 *** Again average measure should be used, as the total equity

Define Return on capital employed (ROCE) and gives its formula

ROCE = fundamental measure of business performance. Expresses the relationship betwen the OPERATING PROFIT generated FOR THE PERIOD and the AVERAGE LONG-TERM CAPITAL INVESTED in the business. The ratio attempts to calculate THE RETURNS TO ALL SUPPLIERS OF LONG-TERM FINANCE BEFORE ANY DEDUCTIONS (for intrest payable dividends and borrowings) = OPERATING PROFIT/TOTAL EQUITY EMPLOYED

Compare the general ROCE of manufacturing bussiness to services businesses

ROCE of manufacturing has been consistently LOWER than that of service companies. This difference ROCE between the two sectors is likely due to to the higher CAPITAL INTENSITY of manufacturing.

Define the acid ratio and give its formula

Ratio comparing current liablilities to current assets (exlcuding inventories) Acid test ratio = current assets (excluding inventories)/ current liabilities. The ACID TEST IS A MORE STRINGENT TEST OF LIQUIDITY than the current ratio. For many businesses, INVENTORIES CANNOT BE CONVERTED INTO CASH QUICKLY. >> This provides a good case to use the acid test instead.

Define sales revenue to capital employed ratio (net asset turnover) and give its formula

Ratio that examines how EFFECTIVELY the ASSETS of the business are being used to GENERATE SALES REVENUE Sales reenu to capital employed ratio = sales revenue / ( share capital + reserves + non-curren liabiliities)

What information can be derived from the cash balance of ALexis given?

Reduction in the cash balance. The cash balance fell from £4 million (in funds) to a £76 million overdraft, between 2009 and 2010. The bank may be putting the business under pressure to reverse this, which could raise difficulties.

Calculate the OCC for Alexis for 2009.

STEPS: 1. Calulate - average inventories turnover period = 56.6 - average settlement period for trade recivebles = 37.7 - average settlement period for trade payables = 44.9 2. Calculating the OCC: OCC = average inventories turnover period + average settlement period for trade recivebles - average settlement period for trade payables = 49.4 therefore it takes 49.4 days before inventory paid for on cash is turned into cash.

Calculate the sales revenue per employee ratio for Alexis for the year end 31 March 2009. Given that 13,995 employees were employed in 2009.

Sales revenue per employee = sales revenue/number of employees = 2240/ 13,995 = 160

Calculate the sales revenue to capital employed ratio for Alexia for the year end 31 March 2009. Given that revenue for the year is 2240, and the long-term capital employeed for 2008 was 683

Sales revenue to capital employed ratio = revenue/ (long-term capital)/2) long-term capital = share capital + reserves + non-current liabilities Sales revenue to capital employed ratio = 2240/(638+763)/2 = 3.20 times 738 = share capital + retained earnings + non-current liabilities

For what industries is the average settlement period for trade recieveables ratio appropriate (or which is it not appropriate for)? Why is this ratio important?

Selling on credit is the norm for most businesses, except for RETAILERS. Trade recievables are a necesary evil. The speed of payment can have a significant effect on the businesses cash flow (it directly affects the businesses ability to pay its own current liabilities - "hand to mouth" relationship). >>> A business will naturally be CONCERNED with the amount of funds tied up in trade recievables and keep this to a minimum.

What ratio categories are generally used by investors?

Sharelders are likely to be interested in their returns in relation to the level of risk assosciated with their investment. Profitability, investment and gearing ratios should therefor be of particular interest.

What ratio categories are generally used by short-term lenders?

Short-term lenders, such as suppliers of goods and services ON CREDIT, are likely to be interested in the ability of the business to repay the amount owing in the short term. Liquidity ratios should therefore be of particular interest.

If the acid ratio falls from 0.8 to 0.6 in a year, what should be concluded by an analyst?

Significant fall May well be a cause for concern. Should lead to steps being taken, at least, to investigate the reason for this, and perhaps, to stop it falling further.

Define gross profit margin and give its formula

Similar to operating profit margin, except replaced with gross profit margin. RELATES the gross profit to the sales revenue generated for the period. GROSS PROFIT represents the difference between sales revenue and the cost of sales >> The ratio is therefore a measure of PROFITABILITY in buying (or producing) and selling goods or services before any other expenses are taken into account. Gross profit margin = (gross prfoti/sales revenue)x100

Why is the OCC important and what is condiered a good OCC?

The OCC is important because it has a significant influence on the FINANCING REQUIREMENTS of the business. Broadly speaking, the longer the cycle, the greater the financing requirements of the business and the greater the financial risks. For this reason, a business may wish to reduce the OCC to the MINIMUM possible period.

What advantage does the Cash generated from operations to maturing obligations ratio have over the current ratio?

The OPERATING CASH FLOES FOR A PERIOD provide a MORE RELIABLE GUIDE TO LIQUIDITY of a business than current assets held at the statement of financial position date.

Define operating cash cycle

The Operating cycle definition establishes how many days it takes for a company to TURN PURCHASE OF INVENTORY (as soon as the CASH PAYMENT is made) into CASH RECEIPTS from its eventual sale. It is also known as cash operating cycle or cash conversion cycle or asset conversion cycle Amazon = negative OCC

Consider the following information, for last year, concerning two different businesses operating in the same industry (photo). Discuss their ROCEs and what they are made up of.

The ROCE for each business is identical (20 per cent). However, the manner in which that return was achieved by each business was quite different. In the case of Antler plc, the operating profit margin is 10 per cent and the sales revenue to capital employed ratio is 2 times (so ROCE = 10% × 2 = 20%). In the case of Baker plc, the operating profit margin is 5 per cent and the sales revenue to capital employed ratio is 4 times (and so ROCE = 5% × 4 = 20%).

Define average inventory turnover period and give its formula

The average inventories turnover period ratio MEASURES THE AVERAGE PERIOD FOR WHICH INVENTORIES ARE BEING HELD. Average inventories turnover period = (average inventories held/cost of sales) x 365 Where the average inventories is a simple average of the opening and closing inventories levels for the year. >> ** However, where inventories levels vary considerably over the year, a monthly average would be more appropriate. Such information may NOT however be AVAILABLE.

Define working capital

The capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities. WORKING CAPITAL = Current Assets - Current Liabilities

What are the 3 key steps to financial ratio analysis?

The three steps involve: firstly, identifying for whom and for what purpose the analysis and interpretation are required; secondly, selecting appropriate ratios and calculating them; and, finally, forming a view based on the information produced

What do you deduce from a comparison of the declines in the operating profit and gross profit margin ratios for Alexis? (photo provided at the back)

The decline in the operating profit margin was 9 per cent (that is, 10.8 per cent to 1.8 per cent), whereas that of the gross profit margin was only 6.8 per cent (that is, from 22.1 per cent to 15.3 per cent). ** This can only mean that operating expenses were greater, compared with sales revenue in 2010, than they had been in 2009. The declines in both ROSF and ROCE were caused partly, therefore, by the business incurring higher inventories' purchasing costs relative to sales revenue and partly through higher operating expenses compared with sales revenue. We should NEED TO COMPARE THESE RATIOS WITH THEIR PLANEED/TARGETED LEVELSbefore we could usefully assess the business's success. The ANALYST must now carry out some investigation to WHAT CAUSED THE INCREASE in both cost of sales and operating expenses, relative to sales revenue, from 2009 to 2010. >>> This will involve CHECKING ON WHAT HAS HAPPENED WITH SALES AND INVENTORY PRICES over the two years. >>> Similarly, it will involve looking at each of the INDIVIDUAL AREAS THAT MAKE UP OPERATING EXPENSES to discover which ones were responsible for the increase, relative to sales revenue. Here, further ratios, for example staff expenses (wages and salaries) to sales revenue, could be calculated in an attempt to isolate the cause of the change from 2009 to 2010. In fact, as we discussed when we took an overview of the financial statements, the increase in staffing may well account for most of the increase in operating expenses.

What is a GOOD curren ratio?

The higher the current ratio, the more liquid the business is considered to be. As liquidity is VITAL TO SURVIVAL of a business, a higher current rratio might be thought to be prefereable to a lower one. If a business has a VERY HIGH RATIO, howver, it may be that EXCESSIV FUNDS TIED UP IN CASH or other liquid assets and are not, therefore, being used as productivly as they might other wise be.

What is a good Cash generated from operations to maturing obligations ratio?

The higher this ratio the better the LIQUIDITY of the business (again you dont want too much cash, because it represents an opportunity cost).

What is the minimum prefered value for the acid test ratio?

The minimum level for this ratio is often stated as 1.0 TIMES (OR 1:1; THAT IS CURRENT ASSETS - excluding inventories- EQUAL CURRENT LIABILITIES). HOEVER, for many businesses it is not unusal for the acid test ratio to be below 1.0 without causing liquidity problems.

Define operating profit margin and give its formula

The operating profit margin relates the operating profit for the period to the sales revenue. Operating Profit Margin = (Operating profit / Sales revenue) x 100 This ratio compare one output of the business (operating profit) with another output (sales revenue) Operating profit is used as a measure of profit at it is normally the most appropriate measure of operational performance. This is because difference arising from the way in which the business is financed will not influence the measure.

What is the relationship between the acid test ratio and the current ratio?

They are similar both compare current liablilities to current assets. But the ACID TEST IS A MORE STRINGENT TEST OF LIQUIDITY than the current ratio. For many businesses, INVENTORIES CANNOT BE CONVERTED INTO CASH QUICKLY. >>> As a result there is a good case for excluding the particular asset.

What do you do if you are calculating a ratio that invovles a value describing a financial aspect for the PERIOD but you are not provided with the opening value?

This is not ideal. Ideally you want both opening and closing balance such that you can calculate the average, and account for the fluctiations in the value over the period. However, where not given you use the closing balance instead of the average through out the ratios calculated. This is for the purpose of CONSISTENCY.

The profitability ratios for Alexia are summarized as follows (photo). What do you deduce from a comparison of the efficiency ratios over the two years?

We feel that maintaining the inventories turnover period at the 2009 level might be reasonable, though whether this represents a SATISFACTORY PERIOD CAN ONLY BE ASSESED BY LOOKING AT THE BUSINESSES PLANNED INVENTORIES FOR THE PERIOD. The inventories turnover period for other businesses operating in carpet retailing, particularly those regarded as the market leaders, may have been helpful in formulating the plans. On the face of things, a shorter receivables collection period and a longer payables payment period are both desirable. On the other hand, these may have been achieved at the cost of a loss of the goodwill of customers and suppliers, respectively. The increased net asset turnover ratio seems beneficial, provided that the business can manage this increase. The decline in the sales revenue per employee ratio is undesirable but, as we have already seen, is probably related to the dramatic increase in the level of staffing. As with the inventories turnover period, these other ratios need to be COMPARED WITH THE PLANNED STANDARD OF EFFICIENCY.

What makes comparison of sales to capital employed ratio between companies more difficult?

When companies the sales revenue to cpaital employed for DIFFERENT BUSINESSES, factors such as the AGE and CONDITION OF ASSETS HELD, the VALUATION BASES for assets and whether ASSETS ARE LEASED or OWNED outirght can complicate interpretation.

What factors should a company consider in order to ensure the shortest possible inventory turnover period?

When judging the amount of inventories to carry, the business must conside such things as: 1. The likely demand for them 2. The possibility of supply shortages 3. The likihood of price rises 4. The amount of storage space available 5. Perishability 6. Susceptibility to obsolence

Is the inventory turnover period sometimes expressed in terms other time measurements than days?

Yes, Sometimes expressed in terms of weeks or monrths rather than days: multiplying by 52 or 12, rather than 365, will achieve this.

If you are not given the figures for share capital, reserves, non-current liabilities how could you calculate capital employed?

long-term capaital employed = Total assets - current liabilities

In the sales to capital employed ratio what makes up the long-term capital employed?

long-term capital employed = share capital + reserves + non-current liabilities

SUMMARIZE What are efficiancy ratios? List the ones convered

● Efficiency ratios are concerned with efficiency of using assets/resources. ● The efficiency ratios covered are the average inventories turnover period, the average settlement period for trade receivables, the average settlement period for trade payables, sales revenue to capital employed, and sales revenue per employee.

SUMMARIZE What are liquidity ratios? List the ones convered

● Liquidity ratios are concerned with the ability to meet short-term obligations. ● The liquidity ratios covered are the current ratio, the acid test ratio, and cash generated from operations to maturing obligations.

SUMMARIZE What are profitability ratios? List the ones convered

● Profitability ratios are concerned with effectiveness at generating profit. ● The profitability ratios covered are return on ordinary shareholders' funds (ROSF), return on capital employed (ROCE), operating profit margin, and gross profit margin.

SUMMARIZE What is the OCC?

● The operating cash cycle is the time period between paying for goods and receiving cash from the sale of those goods.