ANALYSING & INTERPRETING FINANCIAL STATEMENTS

The classical approach to this subject is commonly referred to as ratio analysis. Ratios are
used in a consistent format to compare financial performance over time in order to determine
the current financial position of a company so that its financial health can be established.
The categories of ratios are as follow :

PROFITABILITY
EFFICIENCY
LIQUIDITY
FINANCIAL GEARING
INVESTMENT

Figures to calculate these ratios are mainly taken from the income statement and the balance
sheet.
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PROFITABILITY RATIOS
Name of Ratio

Formula

State result as

1. Return on investment (after interest

and tax)

Net profit after tax

Total net assets (1)

2. Return on investment (after tax

before interest)

Net profit after tax but before interest

Total net assets

3. Gross profit ratio

Gross profit
Sales

4. Net profit ratio (before interest and

taxation)

Net profit before interest and tax

Sales

X 100

5. Net profit ratio (after tax and before Net profit after tax and before interest
Sales
interest)
6. Net profit ratio (after interest and
tax)
(1) NOTE

Net profit after interest and tax

Sales

%
%
%

Total Net Assets

= Total Assets Less Current Liabilities
This Is The Net Worth Of The Business
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103

EFFICIENCY RATIOS
Name of Ratio

Formula

State result as

1. Inventory turnover

Cost of Sales
Average Stock

2. Debtors to sales ratio

Debtors
Sales

X 100

3. Debtor days (collection

period)

Debtors
Sales

X 365

Days

4. Creditors turnover ratio

Creditors X 100
Purchases

5. Creditor days (payment

period)

Creditors X 365
Sales

Days

6. Cash conversion cycle

Inventory days Creditor days +

Debtor days
=
Cash conversion days

Days

7. Sales to capital employed

Sales revenue
Share capital + reserves + long term liabilities

8. Sales per employee

Sales
Number of employees

Times

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104

9. Return on shareholders
funds

Net profit after tax and dividends

Ordinary share + reserves

10. Return on capital

employed

Net profit before interest and taxation

Share capital + reserves + long term loans (2)

11. Asset utilisation ratios

(1) Sales
Fixed assets
(2) Sales
Current assets
(3) Sales
Total assets

Times
Times
Times

(1) NOTE

: Ordinary Shareholder + Reserves = Ownership Capital, these are the

Shareholders Funds

(2) NOTE

: Long Term Loans = Debt Capital

Therefore The Total Capital Employed = Ownership Capital + Debt Capital
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105

LIQUIDITY RATIOS
Name of Ratio

Formula

State result as

1. Current ratio

Current assets
Current liabilities

Ratio

2. Acid test ratio

Monetary current assets

Current liabilities

Ratio

3. Working capital
turnover

Sales
Working capital

Times

(1) NOTE : Working Capital = Current Assets Less Current Liabilities

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106

FINANCIAL GEARING RATIOS

GEARING
Gearing refers to the proportion of fixed interest (Debt), capital in relation to the equity capital
held by the shareholders as owners of the firm. If this proportion is high, then the company is
considered to be taking a high risk position.
New business development plans which require loan financing will increase the gearing of the
enterprise.
Gearing refers to the proportion of debt a company has in its capital structure.
Name of Ratio

Formula

State result as

1. Gearing ratio

Long term liabilities

Share capital + reserves + long term liabilities

2. Debt & Equity ratio

Long term liabilities

Equity share capital

3. Interest Cover ratio

Profit before interest and tax

Interest payable

These gearing ratios will also help to assess the solvency of the business.
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107

INVESTMENT RATIOS
Name of Ratio

Formula

State result as

DIVIDEND PAYOUT
RATIO

Dividends Announced
Profits for the year available for dividends

DIVIDEND YIELD
RATIO

Dividend per share

Market value per share

EARNINGS PER
SHARE

Earnings (profit) available to ordinary shareholders

Number of ordinary share issued

PRICE / EARNINGS
RATIO (PIE)

Market value per share

Earnings per share

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108