Financial Ratio Analysis

Financial Ratio Analysis Financial Ratio analysis is a fascinating topic. To help you through this extensive resource we have broken it down into several sections and subsections. You may move between sections using the navigation in the left hand bar, move between each page in turn by following the links at the bottom of each page or jump to a topic using the list below:

Welcome Ratio Analysis 1: Profitability Ratio Analysis 2: Rate of Return Ratio Analysis 3: Working Capital Management 1: Liquidity Ratio Analysis 4: Working Capital Management 1 continued: Asset usage Ratio Analysis 5: Working Capital Management 2: Stock/debtors/creditors Ratio Analysis 6: Gearing Ratio Analysis 7: Investor

Profitability We will now examine profitability

Ratio Analysis 1: Profitability o Basic:

Gross profit margin Net profit margin

Advanced:

Activity 2 : Carphone Warehouse profit margin Activity 3 : Vodafone profit margin Activity 4 : Advanced profitability (Additional question 1) Additional question 2 Additional question 3 Additional question 4

Basic Profitability

Activity 5 : Carphone Warehouse profitability Additional question 5 Additional question 6

First some basic profitability equations: Gross Profit * 100 Turnover Operating Profit * 100 Turnover

Gross Profit Margin =

Operating Profit Margin =

Net Profit Margin =

Net Profit * 100 Turnover Retained Profit * 100 Turnover

Retained Profit Margin =

Profit Mark up =

Profit * 100 Cost

What are you going to do if someone asks you to tell them whether a business is profitable or not?

By: Mairaj Haider

Financial Ratio Analysis

Firstly, do you remember what profit is? Profit is the difference between turnover, or sales, and costs: that is, profit = turnover - costs One problem is that there are several ways of measuring profit: gross profit; net profit before and after taxation; and retained profit are just some of them. So, you didn't print out those Tesco accounts we showed you did you? Well, look back at them to remind yourself of all these names for profit A profit margin is one of the profit figures we just mentioned shown as a percentage of turnover. They always tell us how much profit, on average, our business has earned per 1 of turnover. We already know from the ratios table that there are several ratios we could use to calculate the profitability of a business. Next we'll discuss gross and net profit margins.

Gross Profit Margin First some basic profitability equations: Gross Profit * 100 Turnover

Gross Profit Margin =

Remember: Turnover = Sales Gross Profit = Turnover - Cost of Sales 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. Gross profit is the profit we earn before we take off any administration costs, selling costs and so on. So we should have a much higher gross profit margin than net profit margin. Net Profit Margin First some basic profitability equations: Net Profit Profit before Interest and Taxation * 100 = * 100 Turnover Turnover

Net Profit Margin =

Remember: Net Profit = Gross Profit - Expenses Why do we have two versions of this ratio - one for net profit and the other for profit before interest and taxation? Well, in some cases, you will find they use the term net profit and in other cases, especially published accounts, they use profit before interest and taxation. They both mean the same: look back at the financial statements for Tesco where we compared different names for the same things. 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. Financial Ratio Analysis - Advanced Profitability - Activity 5 - Carphone Warehouse Advanced Profitability

By: Mairaj Haider

Financial Ratio Analysis

First some advanced profitability equations: Profit before Interest and Taxation * 100 Turnover

PBIT =

PBT =

Profit for the Year * 100 Turnover Net Profit * 100 Turnover

Profit for the Year Margin =

Administration costs % =

Administration costs * 100 Turnover

Interest costs % =

Interest costs * 100 Turnover Total Overhead Costs * 100 Cost

Overhead costs % =

Who uses these Profitability Ratios? Look back at the table of users and what they use to see who might use a profitability ratio... now think about why they use them and what the results tell them. Use the Profitability Ratios 2: more advanced Now that we have worked through some of the basic profitability ratios, let's sharpen our pencils and get our calculators out and do some more advanced analysis... Section Index | Previous | Next | Next Section | Section Map Financial Ratio Analysis - Rate of Return Rate of Return We will now examine Rate of Return

Ratio Analysis 2: Rate of Return o Basic:

Return on capital employed (ROCE)

o
Advanced:

Activity 6 : Vodafone ROCE Activity 7 : Vodafone ROTA Additional question 7 Activity 8 : ROCE and the Pyramid

Return on total assets (ROTA)

Review of ROCE and the Pyramid of Ratios

Return on fixed assets (ROFA) Return on working capital (ROWC)

Additional question 8 Additional question 9 Additional question 10 Additional question 11

Review: Inter-firm and intra-sector analysis

By: Mairaj Haider

Financial Ratio Analysis

Section Index | Previous | Next | Next Section | Section Map Rate of Return First some basic Rate of Return equations: Profit for the Year * 100 Equity Shareholders' Funds

Return on Capital Employed (ROCE) =

Return on Total Assets (ROTA) =

PBIT * 100 Total Assets

The rate of return ratios are thought to be the most important ratios by some accountants and analysts. One reason why the rate of return ratios are so important is that they are the ratios that we use to tell if the managing director is doing their job properly.

By: Mairaj Haider