Ratio Anaysis
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Ratio Analysis
Ratio Analysis
Question 1
The following information is taken from the profit and loss account of two public companies.
Answer
Financial analysis is an integral part of the decision making process. A detailed financial analysis of the two companies is provided here onwards, which encompasses various aspects of financial information. Financial ratio analysis will cover the profitability, efficiency, liquidity and the leverage of the. The financial performance that follows is evaluated and analysed from the perspective of shareholder.
Alpha Plc (£m)
Beta plc (£m)
Sales
55.7
22.3
Cost of sales
(49.1)
(10.2)
Gross Profit
6.6
12.1
Expenses
(4.4) (6.3)
Operating Profit
2.2
5.8
Interest paid
(0.6)
(1.1)
Net Profit before tax
1.6
4.7
Capital employed
8.8
34.3
You have been asked to calculate, for each company, the following ratios and explain what they mean in the form of a short report to management:
Gross Profit percentage
GP Percentage = GP/Sales
Alpha Plc
= 6.6/55.7
= 11.8%
Beta plc
= 12.1/22.3
= 54.2%
Net profit percentage
NP Percentage = NP / Sales
Alpha Plc
=1.6/55.7
= 2.8%
Beta plc
= 4.7/22.3
= 21.1%
Operating profit percentage
Operating Profit % = Operating Profit / Sales
Alpha Plc
=2.2/55.7
= 3.9%
Beta plc
= 5.8/22.3
= 26.0%
(d) Return on capital employed
Return on Capital Employed (ROCE0 = Net Profit / Capital Employed
Alpha Plc
=1.6/8.8
= 18.18%
Beta plc
= 4.7/34.3
= 13.7%
Question 2: The following information is taken from the balance sheets of two companies.
Alpha Plc (£m)
Beta plc (£m)
Stock
3.8
4.1
Debtors
4.5
0.7
Bank Overdraft
0.4
6.3
Creditors
5.1
10.7
Long Term Loans
3.2
2.1
Share Capital
4.5
8.4
Reserves
1.4
4.7
Notes:
Sales for Year
43.9
96.3
Purchases for Year
32.4
85.1
Cost of Sales
33.6
84.7
You are to calculate for each company:
• Working capital ratio
Working Capital for the Companies
Alpha Plc (£m)
Beta plc (£m)
Stock
3.8
4.1
Debtors
4.5
0.7
Working Capital
8.3
4.8
Working Capital Ratio or Net Working Capital = Current Assets minus Current Liabilities
Alpha Plc
= 8.3m - 5.1m - 0.4m
= 2.8m
Beta Plc
= 4.8 - 6.3 - 10.7
= -12.2m
• Liquid capital ratio
Liquid Assets / Current Liabilities
Alpha Plc (£m)
Beta plc (£m)
Bank Overdraft
0.4
6.3
Creditors
5.1
10.7
Total Current Liabilities
5.5
17.0
Alpha Plc (£m)
Beta plc (£m)
Current Assets
Debtors
4.5
0.7
Alpha Plc
= 4.5/5.5
= 0.81
Beta Plc
= 0.7/17.0
= 0.41
• Debtors' collection period
Debtors Turnover = Sales/Debtors
Alpha
43.9/4.5
9.75
Debtors Collection = 365/Debtors Turnover
=365/9.75
= 37.4 days
Beta
96.3/0.7
= 137.5
• Creditors' payment period
365/Creditors Turnover
Credit Turnover = Cost of Goods sold / Creditors
Alpha Credit Turnover
33.6/5.1
= 6.58
Alpha Creditors Payment Period
= 365/6.58
= 55.4 days
Beta Credit Turnover
84.7/10.7
= 7.91
• Stock turnover
Stock Turnover = Cost of Goods Sold / Stock
Alpha = 33.6/3.8
= 8.8 times
Beta = 84.7/4.1
= 20.6 times
• Gearing ratio
Alpha Plc (£m)
Beta plc (£m)
Bank Overdraft
0.4
6.3
Creditors
5.1
10.7
Long Term Loans
3.2
2.1
Total Debt
8.7
19.1
Share Capital
4.5
8.4
Reserves
1.4
4.7
Total Equity
5.9
13.1
Total Debt / Total Equity
Alpha = 8.7/5.9
= 1.47
Beta = 19.1/13.1
= 1.45
Question 3
One company runs a departmental store. The other one is a chemical manufacturer. Which is which? Explain your answer with a short essay. How have ratios helped you analyse the two businesses in the above exercise?
Answer
In attempting to analyze financial statements through the use of financial ratios organizations should have the expertise to interpret them in order to bring about positive changing in the organizational performances (Weston 1990: 295). The paragraphs here onwards interpret the ratios to extract meaningful information for decision-making process from the shareholder's or investor's perspective.
Mathematically, a ratio is one reason, i.e. the relationship between two numbers. In ratios, liquidity ratio is of particular relevance ...