Chapter 6

EVALUATING FINANCIAL
PERFORMANCE
Lecturer: Nguyen Xuan Quang, Ph.D.
Email: quanghvnh@gmail.com
Phone: 0904996748 (working hours only)
Introduction
Evaluation of financial performance
Profitability and return on capital
Borrowing
Liquidity and working capital ratios
Shareholders investment ratios
Reading the financial pages of newspaper
1 . I NTERPRETATI ON OF FI NANCI AL
STATEMENTS
2 . ACCOUNTI NG RATI OS
3 . RATI O COMPARI SONS
Evaluation of financial
performance
Interpretation of financial statements
Beware of the context
Businesses in different industries show very different
results.
Compare like with like
Try to eradicate unusual items or difference in accounting
methods.
Double check the results
Dont base the interpretation on the result of one fact only.
Use data of more than one accounting period.
Accounting ratios
Profitability and
return
Borrowings
Liquidity and
working capital
Shareholders
investment
Ratio comparisons
Ratio
comparison
Other
information
External
Internal
Chairmans and
directors report
Age and nature of the
companys assets
Market, acquisitions
or disposals of a
subsidiary.
Profitability and
return on capital
Profit measures
Profit on ordinary activities before taxation
Profit on ordinary activities after taxation
Profit before interest and tax (PBIT)
Profit growth
Capital
employed
Shareholders
funds
Long-term
liabilities
Return on capital employed (ROCE)
Capital employed
PBIT
ROCE =
ROCE
>
<
=
ROCE last year?
ROCE of competitor?
Current market borrowing rates?
Return on capital employed (ROCE)
Furlong PLC 20x5

20x4

Profit on ordinary activities before tax 342,130 225,102
Interest payable 18,115 21,909
PBIT 360,245 247,011
Shareholders funds 868,899 641,969
Long-term creditors 120,000 110,000
Capital employed 988,899 751,969
ROCE 36.4% 32.8%
Profit margin and asset turnover
( )
Profit
Asset turnover
margin
ROCE
| |
=
|
\ .
Capital employed Capital employed
PBIT Sales PBIT
Sales
=
Profit margin
The percentage of sales remains after deducting expenses.
Asset turnover
The speed at which assets are turned into sales.
Profit margin and asset turnover
Furlong PLC
Profit
margin
Asset
turnover
ROCE
20x5
360,245

3,095,576
=
360,245
3,095,576 988,899 988,899
11.64% 3.13 times = 36.4%
20x4
247,011

1,909,051
=
247,011
1,909,051 751,969 751,969
12.94% 2.54 times = 32.8%
Gross profit margin vs. net profit margin?
Borrowings
Liabilities ratio
Total liabilities
Liabilities ratio
Total assets
=
What if
Liabilities ratio is high?
(> 50% for example)
Liabilities ratio is
increasing or decreasing?
Liabilities ratio
20x5 20x4
Total debts (881,731 + 100,000) (912,456 + 100,000)
Total assets (802,180 + 1,068,450) (656,071 +
1,008,354)
= 52% = 61%
Total liabilities
Liabilities ratio
Total assets
=
Furlong PLC
Gearing ratio
Prior charge capital
Capital carrying a right
to a fixed return:
Preference shares
Debentures
Total capital
Ordinary share capital
and reserves
Prior charge capital
Other long-term
liabilities or provisions.
Prior charge capital
Capital gearing ratio
Total capital
=
Low-geared < Gearing ratio = 50% < high-geared
Gearing ratio
A similar ratio to the gearing ratio:
Prior charge capital
Debt/equity ratio
Ordinary share capital and reserves
=
Low-geared < Debt/equity ratio = 100% < high-geared
Implications of high or low gearing
Interest
charges
Tax
Preference
dividend
Ordinary
dividend
Profit before interest and tax (PBIT)
Fixed
Fixed
Interest coverage
PBIT
Interest cover
Interest charges (less receipts)
=
Low coverage < Interest cover e (2, 3) < Acceptable coverage
Interest
charges
Tax
Dividends
Liquidity and working capital
ratios
Liquidity ratios: current and quick ratios
Current assets
Current liabilities
CR =
Current assets - Stocks
Current liabilities
QR =
Current assets
Current
liabilities
Long-term
liabilites
+
Owners
equity
Fixed assets
CR
QR
1.5
0.8
Efficiency ratios:
control of debtors, stock and creditors
365
Trade debtors
Debtor days days
Sales
=
365
Stock
Stock turnover period days
Cost of sales
=
365
Trade creditors
Creditors' turnover days
Purchases
=
Shareholders investment ratios
Earnings per share and dividend per share
Profit available for ordinary shareholders
Number of ordinary shares
EPS =
Dividend paid out for ordinary shareholders
Number of ordinary shares
DPS =
Dividend cover, P/E ratio and dividend yield
Earning per share
Dividend cover
Net dividend per (ordinary) share
=
Current share price
P/E
Earnings per share
=
100%
Dividend on the share for the year
Dividend yield
Current market value of the share
=