ANALYSIS OF

PUBLISHED ACCOUNTS

(RATIOS)
 PUBLISHED ACCOUNTS
• ‘Income Statement’ and ‘Statement of Financial Position’ are the
two most important statements of the financial position of a
business

• Stakeholders use ratio analysis to gain more information about the

performance of the business from published accounts.

• We have already learned the uses of some ratios from AS level:

1. Gross Profit Margin (Profitability ratio)
2. Net Profit Margin (Profitability ratio)
3. Current Ratio (Liquidity ratio)
4. Acid Test / Quick Ratio (Liquidity ratio)
 RATIO ANALYSIS

• Pro tability ratios: Comparison of the gross and operating profits of the business with
sales revenue. In addition, the return on capital employed ratio is an important measure
of the profit performance of a business.

• Liquidity ratios: Measure of how easily a business could meet its short-term liabilities.

• Financial ef ciency ratios: An indicator of how efficiently a business is using its

resources and collecting its debts.

• Shareholder ratios: Used by existing or potential shareholders to assess the rate of

return on shares and the prospects for their investment.

• Gearing ratios: Examine the degree to which the business is relying on long-term loans
to finance its operations.
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 USE OF RATIO ANALYSIS

1. Identify trends over time

2. Compare rates with results from previous years

3. Help with investment decisions

4. Judges efficiency of resources

5. Assesses the risk involved in borrowing

6. Can be compared to other businesses in the same

market/industry
 PROFITABILITY RATIOS - FROM AS LEVEL

1. Gross Pro t Margin

2. Operating Pro t Margin

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 PROFITABILITY RATIOS
The return on capital employed ratio is an important measure of the pro t
performance of a business

3. Return on Capital Employed (ROCE)

• Measures the rate at which the capital of a business generates profit

• Shows how efficient the capital employed of a business is at generating profit
• Can be an indicator to potential shareholders of returns
• The higher the ROCE rate, the greater the returns
• Stakeholder interest: Shareholders & Potential Investors, Investors
 PROFITABILITY RATIOS

Return on Capital Employed (ROCE)

Compared with:
1. Borrowing cost
2. Rates from previous years
3. Rate of interest from placing in a bank
4. Return from investing in other ventures
5. Competitive analysis
PROFITABILITY RATIOS
 LIQUIDITY RATIOS - FROM AS LEVEL

Current Ratio

Acid Test / Quick Ratio

 FINANCIAL EFFICIENCY RATIOS
An indicator of how ef ciently a business is using its resources and collecting
its debts

1. Inventory Turnover Ratio: Measure of the rate at which inventory enters and
leaves the business

• Value of inventories - average value of inventories at the start and end of year
• Lower the amount of capital tied up in inventories, the better
• Turnover depends on the type of industry - retailers have high inventory
turnover
• Stakeholder interest: Management and Suppliers
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 FINANCIAL EFFICIENCY RATIOS

2. Days’ sales in trade receivables ratio: Measure of the average number

of days that debtors take to pay back to the business.

• Shorter the time it takes to collect debts, the better

• The ratio varies from business to business
• May be deliberately kept high to attract customers
• Stakeholder Interest: Management, Customers & Competitors
 FINANCIAL EFFICIENCY RATIOS

3. Days’ sales in trade payable ratio: Measure of the average number of

days that creditors are paid back.

• Longer times mean that creditors are paid back later

• The ratio varies from business to business
• May be deliberately kept high/low to attract suppliers or a lot of
competition in suppliers
• Stakeholder Interest: Management, Suppliers & Competitors
 SHAREHOLDERS RATIOS
Assess the rate of return on shares and the prospects for their investment

1. Dividend Yield Ratio: Measure the rate of return a shareholder gets at the
current share price

• Dividend per share is calculated using the following formula:

 SHAREHOLDERS RATIOS
Dividend Yield Ratio
• If share price rises, dividend yield will fall (at same dividends amounts)
• If dividend amount increase at same share price, dividend yield will increase.
• Stakeholder interest: Shareholders & Investors

Ratio is compared with:

1. Rates from previous years
2. Return from investing in other companies
3. Competitive analysis
 SHAREHOLDER RATIOS
2. Dividend cover ratio: Calculate how many times the total dividend can
be paid out of the company’s profit (after paying taxes and interest).

• High dividend cover ratio might be difficult to maintain

• Increasing retained earnings would reduce the ratio
• Stakeholder Interest: Shareholders & Investors
 SHAREHOLDER RATIOS
3. Price/Earning Ratio (P/E): Reflects the confidence that investors have in
the future prospects of the business. Shows growth rate of earning in the
future.

• P/E ratio of 10 suggests investors are willing to pay $10 for $1 for earnings
• Higher the P/E ratio, more confidence the investors will have in future earnings
• Only relevant when comparing businesses in the same industry
• Stakeholder Interest: Shareholders & Investors
 GEARING RATIOS
Examine the degree to which the business is relying on long-term loans to
nance its operations.

1. Gearing Ratio: Measures the degree to which capital raised by the business is
financed through long-term liabilities and requires interest payment

• Higher the ratio (above 50%), the more ‘geared’ a business is said to be
• More ‘geared’ means higher interest payment (less dividend paid out)
• Low gearing is a safe business strategy, but provides slow rate of return to
investors
• Stakeholder interest: Banks, Shareholders, Investors and Managers
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 LIMITATIONS OF RATIO ANALYSIS

• Different accounting techniques might have been applied when producing

the financial statements for earlier years.
• Different companies might be using different methods of calculation of items
e.g. depreciation.
• Comparisons with companies in a different industry are unlikely to be of
value.
• Comparing the ratios of businesses of differing sizes can be misleading.
• Ratios are calculated based on published financial information which may be
window-dressed
• Economic conditions could change rendering the results useless
• Ratios ignore qualitative factors of business performance
 • the impact of debt or equity decisions on ratio results
• the impact of changes in dividend strategy on ratio results
• the impact of business growth on ratio results
• the impact of other business strategies on ratio results
• the limitations of using published accounts and ratio analyses

Ratios to support analysis of published accounts

Liquidity ratios
Current assets
Current liabilities Cambridge International AS & A Level Business 9609 syllabus for
Current ratio
Answer presented as a ratio

Current assets – inventory

Acid test ratio Current liabilities
Answer presented as a ratio Gearing ratio
Non-current liabilities
Gearing (%) × 100
Capital employed
Profitability ratios
Gross profit
Gross profit margin (%) × 100
Revenue
Investment ratios
Profit from operations
Operating profit margin (%) × 100
Revenue Market price per share
Price/earnings ratio
Profit from operations Earnings per share
× 100
Return on capital employed (%) Capital employed
Dividend per share
Capital employed = issued shares + reserves + non-current liabilities
Dividend yield (%) × 100
Market price per share

Profit for the year

Dividend cover
Annual dividend
Financial efficiency ratios
Trade receivables
Trade receivables turnover (days) × 365 days
Credit sales

Trade payables
Trade payables turnover (days) × 365 days
Credit purchases

Cost of sales
Rate of inventory turnover (times)
Average inventory

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