financial ratios making sense of revenue statements and balance sheets
TRANSCRIPT
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FINANCIAL RATIOS
Making sense of Revenue Statements
And Balance Sheets
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Introduction
• Financial ratios are calculations that help managers examine the performance of the business.
• They also assist in determining whether the business is meeting its financial objectives.
• Ratios allow comparison over time, with industry averages and with their competitors, they allow for the prediction of trends and assist in planning.
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•IT IS NOT ENOUGH TO SIMPLY CALCULATE RATIOS YOU MUST INTERPRET THEM....
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To begin...
• You must be familiar with The Accounting Equation
• Assets = Liabilities + Owners equity
• This equation is the one that ensures that the Balance Sheet actually balances.
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The types of ratios
• There are several categories of ratios that businesses use and you need to know which ratio falls under which categoryTYPE/CATEGORY OUTLINE
LIQUIDITY SHORT TERM STABILITY
SOLVENCY LONG TERM STABILITY
PROFITABILITY FINANCIAL RETURN
EFFICIENCY RETURN ON COSTS
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Liquidity
• Liquidity measures how easily a business can meet its current liabilities or short term debts.
• It is the relationship between current assets and current liabilities.
• Ideally the business should have more current assets than current liabilities to pay their short term debts as they fall due.
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How is liquidity measured
• By using the Current Ratio
• Current Ratio = current assetscurrent liabilities
Generally the industry standard for liquidity is 2:1. This means that for every dollar of liability the business has 2 dollars of assets to pay for it
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Worked Example
• Using the Coco’s Coastal Cafe Balance Sheet:• A) Determine the level of current assets and
current liabilities• B) Substitute these numbers into the ratio• C) Write a short statement that describes the
current ratio of Coco’s Coastal Cafe ( is it good?)
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Solvency
• Refers to the long term stability of the business and whether it can meet its total financial obligations as they fall due.
• The term used to describe the relationship between debt and equity is gearing. If the business has accumulated more debt than equity it is termed highly geared.
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How solvency is measured
• By using the gearing ratio
• Gearing Ratio = Total liabilities X 100Owners Equity
Generally the industry standard for small business is 50% and for larger business 100% This means for a small business that for every dollar of equity invested the business has generated 50c of debt.
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Worked Example
• Using the Coco’s Coastal Cafe Balance Sheet:• A) Determine the level of total liabilities and
owners equity• B) Substitute these numbers into the ratio• C) Write a short statement that describes the
gearing ratio of Coco’s Coastal Cafe ( is it good?)
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Profitability
• Profitability refers to the businesses ability to make a financial return from their activities.
• Profitability can be determined in 3 ways by calculating:
* Gross Profit Ratio (GPR)* Net Profit Ratio (NPR)* Return on Owners Equity (ROOE)
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Gross Profit Ratio
• This ratio indicates the percentage of each dollar of sales, this is gross profit. It indicates the mark up placed on goods sold.
• Generally the higher this percentage the better as this gives the business better opportunities to account for their expenses
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GPR
• Gross Profit Ratio = Gross Profit X 100GPR Sales
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Worked Example
• Using the Coco’s Coastal Cafe Revenue Statement:
• A) Determine the level of Gross Profit and Sales
• B) Substitute these numbers into the ratio• C) Write a short statement that describes the
GPR of Coco’s Coastal Cafe ( is it good?)
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Net Profit Ratio
• Net Profit Ratio takes into account the expenses of a business and this is how it differs from the GPR.
• The Net Profit Ratio (NPR) will be less than the GPR and if expenses were increasing then the NPR would be decreasing.
• This ratio measures what percentage of each dollar of sales is net profit. 13-20% is good for retail businesses.
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NPR
• Net Profit Ratio = Net Profit X 100NPR Sales
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Worked Examples
• Using the Coco’s Coastal Cafe Revenue Statement:
• A) Determine the level of Net Profit and Sales• B) Substitute these numbers into the ratio• C) Write a short statement that describes the
NPR of Coco’s Coastal Cafe ( is it good?)
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Return on Owners Equity
• This is one of the most important indicators as it shows how much the owners investment and risk in the business is earning.
• A high figure is desirable but the trend over time is more significant
• A figure below 10% would be a concern as the owner could invest in much less risky areas for a similar return. E.g. bank and property investments
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ROOE
• Return on Owners Equity = Net Profit X100ROOE Owners Equity
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Worked Example
• Using Coco’s Coastal Cafe Revenue Statement and Balance Sheet:
• A) Determine the level of Net Profit and Owners Equity
• B) Substitute these numbers into the ratio• C) Write a short statement that describes the
ROOE of Coco’s Coastal Cafe ( is it good?)
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Efficiency
• Efficiency means that a business is the maximum returns for the minimum costs.
• Efficiency ratios provide a tool to determine how efficiently the business is using its assets and spending to create sales and profits.
• There are 2 main efficiency ratios– Expense Ratio– Accounts Receivable Turnover Ratio
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Expense Ratio
• This ratio shows the relationship between sales and expenses used to make those sales.
• The Expense Ratio needs to be as low as possible so that the business can generate a better NPR.
• Strategies are often used to lower the Expense Ratio once it has been determined.
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Expense Ratio
• Expense ratio = expenses X 100sales
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• Using Coco’s Coastal Cafe Revenue Statement:• A) Determine the level of Sales and Expenses• B) Substitute these numbers into the ratio• C) Write a short statement that describes the
expense ratio of Coco’s Coastal Cafe ( is it good?)
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Accounts Receivable Turnover Ratio
• This ratio shows how long it takes for the business to collect money that is owed to them
• A long period is a concern as it means the business’s cash flow could be jeopardised.
• If a business can collect its debts within 14 days that is excellent but anything up to 60 days is acceptable. The lower the number of days the better.
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Accounts Receivable Turnover Ratio
• Accounts Receivable = Accounts ReceivableTurnover Ratio Sales /day
(sales /day is calculated by dividing the value of sales by 365)
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• Using Coco’s Coastal Cafe Revenue Statement and Balance Sheet:
• A) Determine the level of Sales and Accounts Receivable
• B) Substitute these numbers into the ratio remember to divide the sales by 365!!!
• C) Write a short statement that describes the Acc/Rec Turnover Ratio of Coco’s Coastal Cafe ( is it good?)