6 - introduction to financial ratios - profit and efficiency ratios Flashcards
(21 cards)
What is Financial ratios?
Financial ratios is the tool used for this analysing and interpreting financial statements.
Why do we use financial ratios?
Financial ratios are powerful tools to help summarize financial statements and the health of a company or enterprise.
- Financial ratios are used for comparison and tracking of the company’s performance based on financial statements.
- This could be the comparison and tracking of a company’s performance with competitors.
- It could be the comparison and tracking of the company’s performance based on internal benchmarks.
Are we handling resources efficiently? Are used for comparison
Name the type of financial statements
balance sheet, finance statement (income) and cash flow statement.
How does ratios help compare?
- Past periods for the same business
- Similar businesses for the same or past periods
- Planned performance for the business
Why do we do tracking?
Tracking of company performance using internal benchmarks
- The tracking helps the company determine individual financial ratio over a period.
- The tracking helps in spotting trends
Comparison with competitors
- Comparison is made with major competitors to identify whether the company is performing better or worse than the industry average.
EX: return on assets
What is a profitability ratio?
Profitability ratios measure a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity
We want a high ratio = stron performence through revenue generation, profitability, and cash flow
Most value with compared to similar companies or past periods.
In profitability ratios, which catagories are there?
Margin ratios:
company’s ability to convert sales into profits at various degrees of measurement.
- Gross profit ratio
- Operation profit ratio
- EBITDA ratio
- Net profit ratio
- Cash flow ratio
Return ratios:
The company’s ability to generate returns to its shareholders
- Return on asset ratio
- Return on investment capital ratio
- Return on equity ratio
- Return on ordinary share funds
- Return on capital employed
Gross profit margin ratio
Gross profit margin ratio relates the gross profit of the business to the sales revenue generated for the same period
Gross profit Margin = (Gross profit ÷ Sales revenue) x 100%
We want is high
Operating profit margin ratio
The operating profit margin ratio relates the operating profit for the period to the sales revenue.
Operating profit margin ratio = (Operating profit ÷ Sales revenue) x 100%
EX: 1,8% = measure of profitability arising the operating profit is 1.8% = poor performance from a company
TIP: If the gross profit margin is strong but the operating profit margin is weak, it usually means operating expenses are too high.
Terminologies - Capital invested
Capital invested refers to the total amount of money that investors, including both shareholders and creditors, have contributed to a business. It typically includes equity investments by shareholders and debt financing provided by creditors.
Used to calculate ROIC (som viser hvor effektivt virksomheden bruger investeret kapital til at generere overskud)
Terminologies
Capital employed
Capital employed encompasses all the capital used by a company to generate profits, including both equity and debt. It represents the total resources employed in the business operations, including fixed assets, working capital, and other long-term investments.
- Capital employed = Total assets – Current liabilitiesOr
- Capital employed = Equity + Non current liabilities
Terminologies
Average long-term capital invested in a business
The average long-term capital invested in a business refers to the total capital employed by the company over an extended period.
This includes equity (such as common stock and retained earnings) and long term debt (bonds or loans that last longer than a year).
What is ROSF?
The return on ordinary shareholders’ funds ratio (ROSF) compares the amount of profit for the period available to the owners with the owners’ average stake in the business during that same period.
So it shows how efficient the company has used the shareholders money.
ROSF
= {(Profit of the year – preference dividend (the important investors)÷ (ordinary share capital (penge som ejer har lagt ind) + Reserves)} x 100
We find the numbers in Cash flow, statement of financial position (balance sheet) and income statement = Here we are looking for the 4 thing: (Profit of the year – preference dividend)÷ (ordinary share capital + Reserves).
A high ROSF is attractive for investors - the company generates a strong income.
What is ROCE?
ROCE measures the efficiency and profitability of a company’s capital investments. It indicates how well a company is utilizing its capital to generate profits
= relationship between the operating profit generated during a period (year, quarter, month etc.) and the average long-term capital invested in the business
ROCE = {Operating profit ÷ (Share capital + Non-Current liabilities+ Reserves)} x 100%
KEY:
If the company’s ROCE is higher than its cost of capital, it suggests that the company is generating returns that exceed the costs of its capital investments, which is generally considered favorable.
If the company’s ROCE is lower than its cost of capital, it suggests that the company is not generating sufficient returns to justify the capital invested, which may be a cause for concern.
What is Efficiency ratios?
Are we managing resources efficiently.
The following are efficiency ratios:
- average inventories turnover period
- average settlement period for trade receivables
- average settlement period for trade payables
- sales revenue to capital employed
- sales revenue per employee.
What is Average inventories turnover period
Inventories is often a significant investment for a business. For some types of business (for example, manufacturers and certain retailers), inventories may account for a substantial proportion of the total assets held.
That is why it is KEY how it is managed for the company.
The average inventories turnover period ratio measures the average period for which inventories are being held
The higher the better of turns. IN days we want LOWER
OBS however also depending on the industry and your competition.
Average inventories held / cost of sales x 365
What is Average settlement period for trade receivables
How long before we get out money.
Understanding how long credit customers will pay you (the supplier) is important.
You (the supplier) need the capital in due time to ensure that you do not run either on a loss or go under.
Average trade receivables / credits of sales reveune x 365
As short as possible!
What is Sales revenue to capital employed.
The sales revenue to capital employed ratio (or net asset turnover ratio) examines how effectively the assets of the business are being used to generate sales revenue.
sales reveune / share capital + resverses + non current liabilities
We want a higher = more productively in the generation of revenue.
OBS a too high one could be a sign of overtrading on its assets = insufficient assets to sustain the level of sales revenue achieved
what is Average settlement period for trade payable
Measures how long, on average, the business takes to pay those who have supplied goods and services on credit.
We want is as long as possible.
What is Sales revenue per employee
The sales revenue per employee ratio relates sales revenue generated to a particular business resource, that is, labour.
Sales revenue / number of employees
Describe the relationship between Profitability and efficiency
Profitability ratios measure a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity.
And Efficiency ratios are used to try to assess how successfully the various resources of the business are managed.
BUT there is value in evaluating both.
We can do both together = are we profitable and efficient together?
They have impact on each-other.
They say how the company is performing profitability and performance.
EXAM: relationship between them: if you manage them together = performance doing well, then profitability will also go up. To a analyse where you do them both.
