Ratio Analysis

Question 1

Horizontal Anyalsis

Answer 1

For one line item = across row
Absolute Change:
= Reported Amount Current period - Previous period

Relative change
= Absolute change / Previous period reported amount

Question 2

Trend Analysis

Answer 2

Express line item relative to base year :
- Select a base year that is “typical”
- Assign value of 100
- All other years = relative as % of 100

Question 3

Vertical Analysis

Answer 3

Compare line items in Fin stat. to base item
- P&L = % relative to sale or revenue
- FP = % relative to total assets

Question 4

Profitability

Return on Equity (ROE)

Answer 4

Profit available to shareholders
————————————————– x 100
Average shareholders equity
= n %
Takes profit after tax
Equity includes reserves and retained profits

Question 5

Profitability

Return on Assets (ROA)

Answer 5

EBIT
—————————– x 100 = n %
Average total assets

Question 6

Profitability

Profit Margins ( Gross profit margin &EBIT profit margin)

Answer 6

Indicator of Mark up
Gross Profit
———————- x 100 = n %
Sales Revenue

Rate at which sales revenue generates EBIT
EBIT
——————– x 100 = n %
Sales revenue

Question 7

Profitability

Expense ratio

Answer 7

Rate at which revenue is absorbed by a particular expense or cost centre

Selling & Marketing expenses
———————————————- x 100 = n %
Sales revenue

Question 8

Profitability

Cash Flow to Sales Ratio

Answer 8

Rate at which sales revenue generates operating cash flows

Net operating cash flow
————————————– x 100 = n %
Sales revenue
Benchmarks: prior periods, similar firms, EBIT to sale ratio

Question 9

Efficiency

Asset Turnover (ATO)

Answer 9

Sales Revenue
————————– x 100 = n %
Average Total Assets
Benchmarks: prior periods, similar firms

Question 10

Link between Profitability & Efficiency

Answer 10

PM X ATO = ROA

Why is this useful?
- Calculate no. = u can go to these separate ratios and investigate the changes
- Compare firms

Question 11

Efficiency
Inventory Turnover/ Day turnover

Answer 11

Measure of asset efficiency and how long one is held
Average inventory x 365
—————————————- = n days
Cost of sales
Benchmarks: prior periods, nature of good

Question 12

Efficiency

Days Sales Outstanding

Answer 12

MAE avg no. days sales outstanding
Avg Trade receivables x 365
——————————————- = n days
Sales revenue

Benchmarks: prior periods, similar firms, credit terms

Question 13

Effeciency

Days Purchases Outstanding

Answer 13

MAE avg no. days inventory purchases outstanding

 Avg Trade payables x 365  -------------------------------------------- = n days (Cost of sales + net ^ inventory)

Benchmarks: prior periods, similar firms, credit terms

Question 14

Liquidity

Answer 14

The ability of a firm to meet its debts, when they fall due =, is critical to their survival

• Entity must have sufficient working capital
  to satisfy short term requirements and obligations

Question 15

Liquidity

Current Ratio (or Working Capital Ratio)

Answer 15

Current assets
————————- = n:1 or n %
Current Liabilities

Too low: indicates potential problems meeting ST commitments
Too high: indicates inefficient use of assets

Benchmark: prior periods, similar firms, rule of thumb range b/w 1.5 to 2

Question 16

Liquidity

Quick Ratio (or Acid-Test Ratio)

Answer 16

Cash + Receivables
—————————————– = n:1 or n %
Current liabilities-Overdrafts
Excludes inventory, prepayments, overdrafts

Benchmarks: prior periods, similar firms, rule of thumb 0.5 to 0.8

Question 17

Liquidity

Cash Flow Ratio

Answer 17

Net operating cash flow (or CGO)
———————————————— = n times
Current Liabilities
Higher = better
Better than current ratio = considers annual cash flow ( could increase of stay same)
Benchmarks: prior periods, similar firms

Question 18

Capital/Gearing

Debt Ratio

Answer 18

Total liabilities
————————– = n %
Total assets
Benchmarks: prior periods, similar firms, (historically, 60% was high)

Question 19

Alternatives to Debt ratio

Answer 19

Equity ratio = [Total equity/Total assets] -
(100 - Debt Ratio)
Debt : Equity = TL / TE

Question 20

Capital/Gearing

Interest Coverage Ratio (or Times Interest Earned)

Answer 20

Measure of financial risk, interest must be paid
EBIT
———————– = n times
Finance costs

Net fin cost = % expense - % revenue
Benchmarks: prior periods, similar firms, rule of thumb of at least 3 to 4

Question 21

Average Finance interest rate

Answer 21

Avg borrowings / interest bearing liabilities

Question 22

Capital/Gearing

Debt coverage ratio

Answer 22

Measures entity capacity to remain solvent in LT
Non-current liabilities
———————————– = n times
Net operating cash flow
Benchmarks: prior periods, similar firms

Question 23

MPR

Net tangible asset backing (NTAB)

Answer 23

Net assets - intangibles /
WAVE no. of Ordinary shares on issue
= n cents per share

If ntab > share price the co. = undervalued or market has pessimistic view about reliasable values of the tangible assets

Question 24

MPR

Earnings per share (EPS)

Answer 24

Profit available to ordinary S/H /
WAVE no. Ordinary shares on issue
= n cents per share
Acc $ generated per Ord Share

Question 26

MPR

Dividend Payout Ratio

Answer 26

Dividends / Profits
D per share / E per share = n%