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AccountingRatiosFormulas 1

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10 views

AccountingRatiosFormulas 1

Uploaded by

1932godfrey
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Interpretation of Accounts

Leaving Certificate Higher Level

Main users of ratios


 Shareholders ~ potential & existing
 Lenders ~ banks & debenture holders
 Creditors ~ such as suppliers
 Management
 Trade Unions
 Potential takeover bidders

Profitability Ratios

* Return on Capital Employed ~ the return earned by the


company on the total amount (capital) invested in the business.

Net Profit (before interest and tax)* x 100 = %


Total Capital Employed

* Return on Shareholders Equity ~ measures the company’s


return to the ordinary shareholders on the capital held by them.
(Shareholders equity = issued ordinary capital + reserves)

Net Profit (after tax and preference dividend) x 100 = %


Shareholders Equity

* Net Profit Percentage ~ indicates the proportion of each 1


euro received from sales that is net profit.

Net Profit x 100 = %


Sales

Liquidity Ratios

* Current Ratio/Working Capital Ratio ~ measures the ability


of the company to pay its short-term debts as they fall due for
payment. The norm is 2:1.

Current Assets : Current Liabilities


* Acid Test Ratio ~ measures the ability of the company to pay
its short-term debts as they fall due, without selling stock. It is
a truer indicator of liquidity as it shows the ability of the
company to pay short-term debts out of liquid assets. The norm
is 1:1.

Current Assets – Closing Stock : Current Liabilities

Activity Ratios
* Stock Turnover ~ measures the number of times a shop
restocks its shelves (buys and sells) in a year.

Cost of Sales = times


Average Stock

Average Stock = Opening Stock + Closing Stock


2

* Average Period of Credit Allowed (given) to Debtors ~


measures in days/weeks/months the average length of time it
takes our debtors to pay us.

Trade Debtors x 365/52/12


Credit Sales

* Average Period of Credit Received from Creditors ~


measures in days/weeks/months the average length of time it
takes us to pay our creditors.

Trade Creditors x 365/52/12


Credit Purchases

Gearing Ratios
* Debt/Equity Ratio ~ measures the ratio between Debt Capital
(which is loans, debentures and preference shares) and Equity
Capital (Issued ordinary capital and reserves). If the ratio is
greater than 1:1 the company is said to be highly geared, and
less than 1:1 the company is said to be lowly geared, and at 1:1 ,
neutrally geared. It shows the proportion of the company owned
by the ordinary shareholders (the true/real owners of the
company). The greater the proportion of the company owned by
the ordinary shareholders, the lower the financial commitment
to fixed interest debt.
Debt : Equity

* Debt/Total Capital Percentage ~ if debt (fixed interest


capital) as a percentage of the total capital employed is less
than 50%, the company is said to be lowly geared, and this puts
less of a financial burden on the company, and is in a more
favourable position when seeking additional finance from
lenders.

Debt Capital x 100 = %


Total Capital

* Debt/ Equity Capital ~ if this % is less than 100%, the


company is said to be lowly geared.

Debt Capital x 100 = %


Equity Capital

* Interest Cover ~ measures the ability of the company to meet


its interest payments out of current earnings. (the number of
times the company could have paid interest out of net profit).

Net Profit before Fixed/Debenture Interest = times


Fixed/Debenture Interest

5. Investment Ratios
* Earnings per Share ~ measures the amount, in cent, that the
company is capable of earning for each ordinary share issued.

Net Profit after Preference Dividends = cents


Number of Issued Ordinary Shares
* Earnings Yield ~ shows the percentage rate of return earned
by the company for each ordinary share held in the company.
Earnings per Share x 100 = %
Market Price of Share

* Price Earnings Ratio (P/E Ratio) ~ shows the number of years


it would take the company to recoup the current market value
of an ordinary share, at current performance/current earnings.

Market Price per Share = number of years


Earnings per Ordinary Share

* Dividend Per Share ~ is the return, in cent, received by


ordinary shareholders, for each share held by them.

Ordinary Dividends paid = cent


Number of issued ordinary shares

* Price Dividend Ratio ~ shows the number of years it would


take one ordinary share to recoup its value at present payout
rate.
Market Price per Share = number of years
Dividend per Share

* Dividend Cover ~ measures the number of times the company


could have paid dividends out of current earnings.

Alternatively, Dividend Cover = EPS


DPS

Net Profit (after tax and preference dividend) = times


Ordinary Dividends paid & proposed
* Dividend Yield ~ is the rate of return that the ordinary
shareholder can expect to receive based on current market
price
Dividends per Ordinary Share = %
Market Price of Share

Limitations of Ratio Analysis


 Final Accounts do not take into consideration the prevailing
economic conditions, such as a recession in the world market, a
natural disaster, political climate, etc.
 Final Accounts do not take into consideration internal factors
such as staff morale, industrial relations, etc.
 Final Accounts are based on past records, and therefore may
not give a realistic view of future performance.
 Ratios do not allow for seasonal fluctuations.
 Only Final Accounts that have adopted the same accounting
policies such as the rate and basis of depreciation can be
successfully and fairly compared.

Reasons for a falling Gross Profit


 Stock losses ~ theft, wastage, obsolescence
 Lowering of selling prices ~ short term sale, mark downs
 A change in the sales mix ~ a drop in the % of high profit
goods being sold
 Increases in production costs ~ which may not be passed onto
the consumer
 A drop in sales volume or selling price per unit

Improving the financial situation of a company in trouble


 Issue more shares
 Reduce dividend payout
 Sell investments
 Borrow
 Sale & leaseback of fixed assets

Note:
Operating Expenses = Total Expenses minus Debenture Interest.

Operating Profit = Net Profit before Debenture Interest is


taken away
i.e. (Net Profit + Debenture Interest)

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