RatioAnalysis.pptVIP

Ratio Analysis Ratio Analysis Ratio Analysis Purpose: To identify aspects of a business’s performance to aid decision making Quantitative process – may need to be supplemented by qualitative factors to get a complete picture 5 main areas: Ratio Analysis Liquidity – the ability of the firm to pay its way Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital Profitability – how effective the firm is at generating profits given sales and or its capital assets Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets Liquidity Acid Test Also referred to as the ‘Quick ratio’ (Current assets – stock) : liabilities 1:1 seen as ideal The omission of stock gives an indication of the cash the firm has in relation to its liabilities (what it owes) A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it owes – very healthy! A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash to pay for those liabilities. This might put the firm under pressure but is not in itself the end of the world! Current Ratio Looks at the ratio between Current Assets and Current Liabilities Current Ratio = Current Assets : Current Liabilities Ideal level? – 1.5 : 1 A ratio of 5 : 1 would imply the firm has ￡5 of assets to cover every ￡1 in liabilities A ratio of 0.75 : 1 would suggest the firm has only 75p in assets available to cover every ￡1 it owes Too high – Might suggest that too much of its assets are tied up in unproductive activities – too much stock, for example? Too low - risk of not being able to pay your way Investment/Shareholders Investment/Shareholders Earnings per share – profit after tax / number of shares Price earnings ratio – market price / earnings per share – the higher the b