Ratio Analysis

Ratio analysis is to do with the past and the firms past performance.
Liquidity ratios:
Current ratio = current assets current liabilities
e.g. 1.1.5 which means for every 1 of current liabilities the business has 1.15 of current assets
Acid test ratio = (Current assets Inventories) divided by current liabilities
e.g. 0.95 which means that for every 1 of current liabilities, it has only 0.95 in current assets
Profitability ratios
Profitability ratios allow for the analysis of a firms profits in relation to either its trading performance e.g.
its sales revenues
Gross profit margin: Gross Profit X100
Revenue
Gross Profit = Turnover - Cost of Sales = the profit before cost of sales has been deducted
The gross profit margin ratio tells us the profit a business makes on its cost of sales, or cost of goods sold. It
is a very simple idea and it tells us how much gross profit per 1 of turnover our business is earning.
Net profit margin (operating profit margin): Net profit X100
Revenue
Net profit = Gross Profit Expenses = it is the profit before interest and taxation
The net profit margin ratio tells us the amount of net profit per 1 of turnover a business has earned. That is,
after taking account of the cost of sales, the administration costs, the selling and distributions costs and all
other costs, the net profit is the profit that is left, out of which they will pay interest, tax, dividends and so
on.
Operating profit margin (OPM)
Operating profit margin % = Operating profit Sales Revenue x 100
R.eturn O.n C.apital E.mployed (ROCE)
Definition: a measure of how efficiently a business is using its capital to generate profit
ROCE % = Operating profit (Total equity+non-current liabilities) x 100
Financial efficiency ratios
Used to asses how efficiently management are controlling the financial operations of the business.
Asset turnover = Sales Net Assets
Inventory turnover is a measure of how many times a business turns over its inventories in a year.
Inventory turnover = Cost of sales Inventory
Payables (creditor days)
Payables days is a measure of the average amount of time it takes to pay for supplies purchased on credit
and is expressed as a number of days.

Payables days = (Payables x 365 days) Credit purchases

Receivables (debtor days)
Receivables days is a measure of the average number of days it takes to receive payments from
customers.
Receivables (debtor) days = (Receivables x 365 days) Revenue
Gearing ratio
Measure of a firms capital that is funded by long-term loans
Gearing ratio % = Non-current liabilities (Total equity+non-current liabilities)
Shareholder ratios
Dividend per share (DPS)
Calculation of how many pence per share a shareholder can expect to receive in dividends.
Dividend per share = Total dividends Number of issued shares
Dividend yield
Its a measure of the dividend received as a rate of return compared to the current market share price.
Dividend yield = (Dividend per share Market share price) x 100
Operations management
Operational strategies
Location: Optimal location: A business location that gives the best combination of quantitive and
qualitative factors
Quantative factors these are measurable in financial terms and will have a direct impact on either the
costs of a site or the revenues from it and its profitability.

Financial data to measure performance

Income statement: a financial document that summarises a businesss trading activity and expenses to show
whether it has made a profit or a loss.
Profit quality: the sustainability of profit
Profit Utilisation: how profit is being used i.e. whether it is being ploughed back into the business or
distributed to shareholders.
Balance sheet: a financial document that summarises the net worth of a business, what it owns and what it
owes and balances total assets with total equity and liabilities.
Total equity: the total amount of money being utilised in the business from share capital and retained profit.
Fixed assets (non-current assets): items of value owned by the business that are likely to be kept for more
than one year e.g. buildings, cars
Current assets: resources owned by the business whose value varies as a result of daily business activities
e.g. cash, stock
Intangible assets: purchased items without physical form such as goodwill or brand names
Current liabilities: financial obligations of the business payable within 12 months e.g. creditors
Long-term liabilities (non-current liabilities): debts that the business has more than one year to repay e.g.
bank loan
Net current liabilities: current liabilities plus current assets
Net assets: total assets minus total liabilities
Working capital: a measure of a firms ability to meet day-to-day expenses
Calculated: Current assets current liabilities
If business cannot generate enough cash in the short
term to pay its short-term liabilities, then it may be forced to liquidate its fixed assets without which it
cannot continue to operate.
Depreciation: an accounting practice which allows the value of a fixed asset to be spread over its useful life
e.g. matching the cost of an asset to its usage
Trade receivables: amounts owed by debtors to the business
If these are high it may be because of
fierce competition in the market and the need to offer more favourable credit terms to achieve a competitive
advantage or may be a sign of internal weakness.
Trade payables: amounts owed by the business to creditors
If these are low a business might want to
negotiate more favourable payment terms so that it could improve its cash flow
Inter-firm comparisons
Inter-firm comparisons means between different firms e.g. one firm might look at another successful firm in
order to set targets for future performance.
Intra-firm comparisons
Intra-firm means within the business and might include comparisons between branches or divisions
Trend analysis (extrapolation)
Helping to extrapolate (guess) a trend into the future
Decision-making
All decisions within the business are going to be influenced in some way by the current financial situation
Financial strategies
Financial strategy: the long-term financial plan of action to achieve the financial objectives of the business
e.g. to lower costs to a point where they are below those of key competitors

Key Terms
Debenture: A form of long-term loan that carries a fixed rate of interest, a specific repayment date and is
often secured against the companys assets.
Profit centre: Any part of a business that can be identified as having its own costs and revenues, and for
which an individual income statement can be drawn and profit for that area calculated.
Retained profits: The part of the profit after tax that is available for distribution, kept by the company for
reinvestment purposes.
Rights issues of shares: When a PLC offers existing shareholders the right to buy more shares in the
company, often at a discount on the current market value to encourage purchase.
Sources of finance
Short, medium and long-term finances long term used to fund capital expenditure in fixed assets or longterm projects. Finances to fund strategic development or retrenchment. Largest source is retained profit.
External sources of finance: equity share capital and debt (loans).

Equity share capital

Debt
Exists for an unlimited term
Exists for a fixed term
Carries a voting right
Does not carry a voting right
Dividends payable dependent upon company performance Interest payable regardless of company
Dividends paid after tax and therefore do not affect tax liability performance
Ordinary shareholders are towards the bottom of the list
Interest paid before tax and therefore reduces
when payments are being made following the closure of a company tax liability
Not secured
Lenders are towards the top of the list when
payments are being made following the closure of a company
Will be secured against an asset
Equity share capital
Raising finance for the business through the sale of shares. Additional share capital can be issued by
releasing more of the authorised share capital. This can be done through a rights issue whereby existing
shareholders are offered the right to buy a number of new shares. The amount offered depends upon the
number of shares that they already have these shares offered at a price below their market value.
Shareholders must be consulted if the business wants to sell shares to outside parties/people as doing so will
reduce their share of the company.
Debt
Finance obtained from banks less risk than equity capital as loan secured against an asset. Asset can then
be seized on order to recoup the money still owed by the company. Interest payments compulsory and firm
can become highly geared risky.
Profit centres
A section of a business for which costs and revenues and therefore profit can be identified. They help to
identify the financial performance of individual sections within a business e.g. underperforming products or
departments, allow for greater delegation of responsibility and acts to motivate managers. If each section
within a business is working to achieve their targets and is aware of the responsibility they have for
maximising revenue and minimising costs this will help the business to achieve a competitive advantage.
They are only appropriate when a subsection of a business can take responsibility for its own revenues and
costs.
Cost minimisation

The assumption that any enterprise will try to produce its output at the lowest possible cost. It refers to the
cost of providing goods or services of a specified quality; it does not mean achieving lower costs by cutting
standards.
It allows a business to compete on price a business that has a high market share or is a market leader will
be in a position of power when it comes to negotiating terms and conditions with suppliers and so may
adopt a strategy which includes an aggressive approach to negotiating prices for goods and services.
Alternatively a business might aim to reduce the cost of managing resources by adopting just-in-time. This
is when raw materials are received when they are needed and finished goods despatched onto the customer,
then it can avoid the costs associated with holding stocks.
Capital expenditure
Is when the purchase of assets that will remain in the business in the medium to long term are accounted for
in the balance sheet e.g. a machine, delivery van etc
Investment appraisal
The process of analysing the financial merits of a possible future investment