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Ratio analysis
2017-18
FINANCIAL RATIOS
I Gearing ratio: long-term financial position
I Profitability ratio: shows how well business is doingI Return on capital employed (ROCE): measures profitability of
business
FINANCIAL RATIOS
I Gearing ratio: long-term financial positionI Profitability ratio: shows how well business is doing
I Return on capital employed (ROCE): measures profitability ofbusiness
FINANCIAL RATIOS
I Gearing ratio: long-term financial positionI Profitability ratio: shows how well business is doingI Return on capital employed (ROCE): measures profitability of
business
GEARING RATIOSDEFINITION
I Relationship between
I loans on which interest is paid, andI shareholders’ equity on which dividends might be paid
I Formula:
gearing ratio =non-current liabilities
capital employed× 100%
GEARING RATIOSDEFINITION
I Relationship betweenI loans on which interest is paid, and
I shareholders’ equity on which dividends might be paid
I Formula:
gearing ratio =non-current liabilities
capital employed× 100%
GEARING RATIOSDEFINITION
I Relationship betweenI loans on which interest is paid, andI shareholders’ equity on which dividends might be paid
I Formula:
gearing ratio =non-current liabilities
capital employed× 100%
GEARING RATIOSDEFINITION
I Relationship betweenI loans on which interest is paid, andI shareholders’ equity on which dividends might be paid
I Formula:
gearing ratio =non-current liabilities
capital employed× 100%
GEARING RATIOSDEFINITION
I Relationship betweenI loans on which interest is paid, andI shareholders’ equity on which dividends might be paid
I Formula:
gearing ratio =non-current liabilities
capital employed× 100%
GEARING RATIOSINTERPRETATION
I highly geared: loans are high relative to share capital
I as business gets highly geared:→ creditors consider the business to be more risky
I if gearing ratio ≈ 25%→ business is not overburdened with long-term debt
I if gearing ratio > 50%→ large proportion of business finance is borrowed
I if gearing ratio is low→more finance is provided by shareholders (owners)
GEARING RATIOSINTERPRETATION
I highly geared: loans are high relative to share capitalI as business gets highly geared:→ creditors consider the business to be more risky
I if gearing ratio ≈ 25%→ business is not overburdened with long-term debt
I if gearing ratio > 50%→ large proportion of business finance is borrowed
I if gearing ratio is low→more finance is provided by shareholders (owners)
GEARING RATIOSINTERPRETATION
I highly geared: loans are high relative to share capitalI as business gets highly geared:→ creditors consider the business to be more risky
I if gearing ratio ≈ 25%→ business is not overburdened with long-term debt
I if gearing ratio > 50%→ large proportion of business finance is borrowed
I if gearing ratio is low→more finance is provided by shareholders (owners)
GEARING RATIOSINTERPRETATION
I highly geared: loans are high relative to share capitalI as business gets highly geared:→ creditors consider the business to be more risky
I if gearing ratio ≈ 25%→ business is not overburdened with long-term debt
I if gearing ratio > 50%→ large proportion of business finance is borrowed
I if gearing ratio is low→more finance is provided by shareholders (owners)
GEARING RATIOSINTERPRETATION
I highly geared: loans are high relative to share capitalI as business gets highly geared:→ creditors consider the business to be more risky
I if gearing ratio ≈ 25%→ business is not overburdened with long-term debt
I if gearing ratio > 50%→ large proportion of business finance is borrowed
I if gearing ratio is low→more finance is provided by shareholders (owners)
RETURN ON CAPITAL EMPLOYED (ROCE)DEFINITION
I Compares the profit made with the amount of moneyinvested.
I ”Profit” is defined as operating profit (also known asearnings before interest and tax EBIT)
I Formula:
ROCE =operating profit
capital employed× 100%
RETURN ON CAPITAL EMPLOYED (ROCE)DEFINITION
I Compares the profit made with the amount of moneyinvested.
I ”Profit” is defined as operating profit (also known asearnings before interest and tax EBIT)
I Formula:
ROCE =operating profit
capital employed× 100%
RETURN ON CAPITAL EMPLOYED (ROCE)DEFINITION
I Compares the profit made with the amount of moneyinvested.
I ”Profit” is defined as operating profit (also known asearnings before interest and tax EBIT)
I Formula:
ROCE =operating profit
capital employed× 100%
RETURN ON CAPITAL EMPLOYED (ROCE)INTERPRETATION
I General rule: the higher the ratio the better
I Compare ROCE:
I of the same company over time(e.g., ROCE2013 and ROCE2014)
I of different companies within the same industry
I For investments to be worthwhile:→ ROCE >> return on safe investment
RETURN ON CAPITAL EMPLOYED (ROCE)INTERPRETATION
I General rule: the higher the ratio the betterI Compare ROCE:
I of the same company over time(e.g., ROCE2013 and ROCE2014)
I of different companies within the same industry
I For investments to be worthwhile:→ ROCE >> return on safe investment
RETURN ON CAPITAL EMPLOYED (ROCE)INTERPRETATION
I General rule: the higher the ratio the betterI Compare ROCE:
I of the same company over time(e.g., ROCE2013 and ROCE2014)
I of different companies within the same industry
I For investments to be worthwhile:→ ROCE >> return on safe investment
RETURN ON CAPITAL EMPLOYED (ROCE)INTERPRETATION
I General rule: the higher the ratio the betterI Compare ROCE:
I of the same company over time(e.g., ROCE2013 and ROCE2014)
I of different companies within the same industry
I For investments to be worthwhile:→ ROCE >> return on safe investment
RETURN ON CAPITAL EMPLOYED (ROCE)INTERPRETATION
I General rule: the higher the ratio the betterI Compare ROCE:
I of the same company over time(e.g., ROCE2013 and ROCE2014)
I of different companies within the same industry
I For investments to be worthwhile:→ ROCE >> return on safe investment
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparison
I comparison over time (changing industries)I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)I Qualitative information is ignoredI Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)
I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)I Qualitative information is ignoredI Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)I inter-firm comparison (comparable companies)
I other differences (accounting standards/techniques,methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)I Qualitative information is ignoredI Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)I Qualitative information is ignoredI Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)
I Limitations of the balance sheet (snapshot of a point inyear→ representative?)
I Qualitative information is ignoredI Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)
I Qualitative information is ignoredI Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)I Qualitative information is ignored
I Window dressing
LIMITATIONS OF RATIO ANALYSIS
I Basis for comparisonI comparison over time (changing industries)I inter-firm comparison (comparable companies)I other differences (accounting standards/techniques,
methods for calculation)
I Quality of final accounts (e.g., window dressing)I Limitations of the balance sheet (snapshot of a point in
year→ representative?)I Qualitative information is ignoredI Window dressing