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Which is better?
Company A has 100,000 profit Company B has 1m profit
Which is better?
Company A has 100,000 profit, where 200,000 was the capital invested Company B has 1m profit, where 10m was the capital invested
Which is better?
Company A has 100,000 profit, where 200,000 was the capital invested
100,000/200,000 x100
= 50%
1m / 10m x100
Profitability ratios
Gross Profit Margin *
Operating Margin * ROCE
* Covered in AS BUSS2
Profitability Ratios
The primary ratio. ROCE return on capital employed This tells us how efficient the company is by looking at their profits & comparing it to the funds invested in the business.
ROCE =
Burberry B.P.
Tesco
Cadbury Schweppes
2,648m
796m
Which company do you Which company think might be the looks the more most efficient at impressive just generating profits? on raw profit figure? Remember to consider the reasons why?
Burberry B.P.
Tesco
Cadbury Schweppes
2,648m
796m
16,655m
6,706m
Company
Burberry B.P.
ROCE
Tesco
Cadbury Schweppes
2,648m
796m
16,655m
6,706m
ROCE
Burberry B.P.
37.44% 20.37%
$158,845m
Tesco
Cadbury Schweppes
2,648m
796m
16,655m
6,706m
15.90%
11.87%
Evaluating ROCE
Higher % is better
ROCE %
Watch for trend over time Watch out for low quality profit which boosts ROCE
Leased equipment will not be included in capital employed
and in A2 you will be given credit for looking at this profitability ratio again!
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 the business is earning.
For example,
A 40% GPM means for every 1 sold 40p equates to gross profit A 14% GPM means for every 1 sold 14p equates to gross profit 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.
Gross Profit
9.64%
5.62%
35.14%
11.41%
27.46%
12.63%
47.52%
89.55%
The Gross Profit Margins may vary from business to business and industry to industry. What does the
Gross Profit For example, the International Airline has a gross profit of 5.62% yet the Accounting Software business has 89.55% Margin also tell us
If a companys raw materials and factory wages go up a lot, the gross profit margin will sales? go down unless the business increases its selling prices at the same time.
x 100 =
The Net profit margin ratio tells us of net profit per 1 of turnover. That is, after taking into account the cost of sales, administration costs, the selling and distribution costs, the net profit is the profit that is left, out of which they will pay interest, tax, dividends and so on.
Leisure & Hotel International Airline Manufacturer Retailer Discount Airline Refining Pizza Restaurants Accounting Software
Net Profit
7.36%
4.05%
-10.48%
1.63%
10.87%
11.99%
7.55%
27.15%
Just like the gross profit margins, the net profit margins also vary from business to business and industry to industry. When we compare the gross and net margins we can gain a good impression of their non-production and non-direct costs such as administration, marketing and finance costs. We saw that the International airlines gross profit margin was the lowest of the 8 industries at 5.62% but its net profit margin is 4.05%, only a little bit lower. On the other hand, the discount airline gross profit margin is 27.46% but its net profit margin is 10.87% These comparisons give us a great insight into the cost structure of these businesses.
Gross Profit
9.64%
5.62%
35.14%
11.41%
27.46%
12.63%
47.52%
89.55%
International Airline
Manufacturer
Retailer
Discount Airline
Refining
Pizza Restaurants
Accounting Software
Net Profit
7.36%
4.05%
-10.48%
1.63%
10.87%
11.99%
7.55%
27.15%
So whats happened to Manufacturing?
Look at the software business a very high GPM of 89.55% but a NPM of 27.15% . This is still high, but we can see that the administrations costs are very high while the costs of sales are very low.
Ratio formula
Gearing
This tells us how much of the companys finance is through debt! A highly geared business is funded heavily through long term debts
Gearing
A company with 80% gearing. has 80% of funds through long term debts and 20% through owners/shareholders. A company with 35% gearing has 35% of funds through long term debts and 75% through owners/shareholders.
Calculating Gearing
Gearing = non current liabilities x 100 total equity & non current liabilities* Aka capital employed So if a company has 280 in non current liabilities and 1,000 in capital employed
Gearing =
BA
Tesco Morrisons
31/3/08
23/2/08 29/7/08
4,646m
7,999m 1,356m
Ratio formula
Liquidity ratios
Assess whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due
Liquidity ratios.
What is liquidity? Liquidity is an asset's ability to be easily converted through an act of buying or selling without causing a significant movement in the price and with minimum loss of value.
Liquidity Ratio
These tell us how healthy the business is in the SHORT TERM It tells us whether the working capital is sufficient to cover the immediate debts!
Current Ratio Acid Test Ratio
Quick recap
What is the money owed to a business from customers called on the balance sheet?
Receivables (from debtors)
Current Ratio
A liquidity ratio
Current Ratio
Current Ratio = current assets : current liabilities or Current Ratio = Current assets
Current liabilities
So what do you think a current ratio of 2:1 means? The company has 2 of assets for every 1 of debt
Which company looks the more impressive just the figures? Current on Current liabilities ratio
BA
Tesco Tate & Lyle Burberry
31/3/08
23/2/08 31/3/08 31/3/08
3,148m
6,300m 1,695m 588.4m
3,244m
10,263m 1,204m 436.2m
Calculate their Current Assets ratio = current assets / current liabilities Written as ? : 1
Company
Current liabilities
ratio 0.97:1
BA
Tesco Tate & Lyle Burberry
31/3/08
23/2/08 31/3/08 31/3/08
3,148m
6,300m 1,695m 588.4m
3,244m
ACID TEST RATIO =(current assets inventories) : Current liabilities Or ACID TEST RATIO = Current assets inventories Current liabilities
It can depreciate if sold as 2nd hand rather than produced into final product.
Quick Q
If Tesco has a current ratio of 0.61:1, what do you think their Acid Test Ratio will be? Will it be higher or lower than this?
BA
Tesco Tate & Lyle Burberry
31/3/08
23/2/08 31/3/08 31/3/08
3,148m
3,870m 1,133m 318.4m
3,132m
10,263m 1,204m 436.2m
Company
Current liabilities
ratio
BA
Tesco Tate & Lyle Burberry
31/3/08
23/2/08 31/3/08 31/3/08
3,148m
3,870m 1,133m 318.4m
3,132m
1.01 :1
Stock turnover
Debtor days
Creditor days
Asset Turnover
This tells us how well the company uses all its assets to generate its sales
Asset turnover =
* where net assets are Total Assets -Total liabilities * this is also the total equity figure at the bottom of the balance sheet.
Stock Turnover
Stock Turnover
This tells us the number of times a business will sell & replace its stock. A fishmonger should have a HIGH stock turnover of 365 times as it gets fresh fish delivered every day of the year! Where as a second hand car dealer may have a stock turnover of 12 times which is selling & replacing its cars on the forecourt once a month!
1. List three business that would have a high stock turnover and three that would have a low figure for stock turnover. 2. A bread shop has an opening stock of 5 000 at the start of the financial year and at the end of the year its stock is 6 000. The cost of sales for the shop is 55 000. Calculate its stock turnover.
Debtor Days
Debtors are known as receivables Debtor days = receivables x 365 revenue
This tells us how much credit the company gives to its customers.
Sofa companies often give buy now pay later options whereas at the local petrol station I have to pay immediately!
Creditor Days
Creditors are known as payables Creditor days = payables x 365 revenue
This tells us how long the company takes to pay back the money it owes to its suppliers. Delaying payment for as long as possible can help the business! BUT can cause problems with suppliers in future! BUT can incur interest charges (Late Payment Act 1998!)
Ratio formula
Shareholder ratios
Dividend per share Dividend yield
In 2008 M&S anounced dividends of 343.6m for 1,586.48m shares 21.65p per share.
Obviously the higher the dividend the better for shareholders! The lower the dividend per share might mean that the company is retaining profit for investments!
Dividend Yield
Dividend Yield = Dividend per share x 100 Market price of share
So using the M&S calculation previously, if the share price was 220p on one day the Dividend yield would be 21.65/220 x 100 = 9.48% You would need to compare this figure with past figures & can vary greatly with fluctuations in the stock market!
Ratio name
Why is it a bad situation for a company to have a gearing of 90%? Dividend per share 80p Dividend yield 5%
Interpreting Ratios
Textbook p169 B1 .. Do Q3 Which business would you buy based on the quantitative factors?
Asset Turnover Inventory / Stock Turnover Payable days (assume payables are
50% of current liabilities for your calculation)
Receivable days
Answers
Profitability ratio
Income Statement Revenue Cost of sales Gross profit Expenses Operating profit Finance income Finance cost Profit before tax Taxation Profit for the year m 35400 (30100) 5300 (720) 4580 300 (260) 4620 (1109) 3511 Balance Sheet Non-current assets Inventories Receivables Cash & cash equivalents Total current assets Current liabilities Net current liabilities Non-current liabilities Net assets Share capital Reserves & retained earnings Total equity ROCE Operating profit x 100 total equity + non-current liabilities 4580 11235 + 6000 x 100 m 19550 2375 1170 2300 5845 (8160) (2315) (6000) 11235 6000 5235 11235
For every 1 of capital employed in the business how much is being generated in profit? Why would it be meaningful to compare this to the current rate of interest? Why might a high street retailer compare ROCE between individual stores?
4580 17235
x 100 = 27%
Gearing ratio
Income Statement Revenue Cost of sales Gross profit Expenses Operating profit Finance income Finance cost Profit before tax Taxation Profit for the year m 35400 (30100) 5300 (720) 4580 300 (260) 4620 (1109) 3511 Balance Sheet Non-current assets Inventories Receivables Cash & cash equivalents Total current assets Current liabilities Net current liabilities Non-current liabilities Net assets m 19550 2375 1170 2300 5845 (8160) (2315) (6000) 11235
Gearing Non-Current Liabilities x 100 total equity + non-current liabilities 6000 (11235 + 6000) = 6000 x 100 17235 =35% x 100
For every 1000 invested in this business how much of it is from long term loans? Why might a high gearing be more of a concern to a business with small profit margins?
Liquidity ratios
Current Ratio Current Assets : Current Liabilities 5845 : 8160 = 0.716 : 1 For every 1 of CL the firm owes it owns 0.716 in CA
Balance Sheet Non-current assets Inventories Receivables Cash & cash equivalents Total current assets Current liabilities Net current liabilities Non-current liabilities Net assets Share capital Reserves & retained earnings Total equity m 19550 2375 1170 2300 5845 (8160) (2315) (6000) 11235 6000 5235 11235
Acid Test Liquid Assets : Current Liabilities 1170 + 2300 : 8160 = 3470 : 8160 = 0.425 : 1 For every 1 of CL the firm owes it owns 0.425 in CA
= 3.15 times
Inventory/ Stock Turnover Cost of sales Inventory 30100 2375 =12.67 times
On average for how long does this business hold stock? What type of business might have this level of inventory turnover? Justify your answer
Why might it be more accurate to divide by average inventory held rather than just inventory?
m 19550 2375 1170 2300 5845 (8160) (2315) (6000) 11235 6000 5235 11235
Receivables Revenue
1170 x 365 35400 = 12 days
x 365
Interpreting Ratios
Dodgy scanning
Interpreting Ratios
HOMEWORK 2
Yellow Work booklet 5 pages
Homework 1
Read textbook chapter on Ratios well be continuing with these next lesson