Financial ratios

• Tourism
• Foundation Degree

Ratio analysis and Financial Performance 

Lesson objectives 

•Describe the purpose of financial ratios

• Describe how to calculate eight financial ratios

• Distribute assignment 1 - do task 1 and 2

First though.....recap on balance sheets 

A balance sheet contains......

1. Current assets
2. Non current assets
3. Current liabilities
4. Non current liabilities

Fixtures and fittings would be....

1. Current asset
2. Non current asset
3. Current liability
4. Non current liability

Which are current assets?

1. Stock
2. Cash
3. Vehicles
4. Computers

Which are non current liabilities?

1. Mortgage
2. Overdraft
3. Bank loan (10 years)
4. Creditors

How do you feel about ratio analysis?

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Have you studied ratio analysis before?

Yes

No

Ratio analysis is used to interpret the financial information contained within the income statement and the Statement of Financial Position 

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What are ratios?

Ratios are figures which express the key relationships in a set of accounts by comparing one figure with another.

They are metrics used to evaluate the financial health and performance of a company. They are crucial for both internal management and external stakeholders like investors, analysts, and creditors. Financial ratios are taken from a company's financial statements, including the balance sheet, income statement, and cash flow statement.

Ratio analysis is used to:

- Assess the organisation's financial performance 

- Evaluate the financial stability of the organisation 

- Predict the future performance and stability of the organisation 

What benefits would comparing ratios over two years give the company?

What external factors impact on a business but are not identified through ratio analysis?

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Benefits of ratio analysis 

Simplifies Financial Data: 

Facilitates Comparison (Benchmarking)

Enables comparison with competitors or industry standards.

 Compares a company's performance over different time periods to identify trends.

Aids Decision-Making and Forecasting

Assesses Key Financial Metrics

Liquidity & Solvency: Determines if a company can meet short-term liabilities and long-term debt obligations.

Profitability: Measures the ability to generate earnings relative to sales, assets, or equity.

Operating Efficiency: Indicates how well management is utilising assets.

Ratio analysis provides a standardized, objective view of financial health, enabling better, faster, and more informed decision-making. 

Limitations of ratio analysis 

Historical Nature: Ratios use past data, which may not reflect current or future conditions.

No Qualitative Insight: Non-financial factors, such as brand reputation, employee morale, and management expertise, are overlooked.

Inflation Distortions: Inflationary pressures can render comparisons over time.

Window Dressing: Companies may manipulate financial statements at the end of a period to make ratios appear healthier.

Ignores External Factors: Ratios do not account for external impacts, such as economic downturns, recessions, or sudden market changes.

Size Differences: Comparing small companies to large firms can be misleading, as their operational structures can be different.

Three types of ratio for you to learn 

Profitability 

Performance 

Liquidity 

Profitability - These ratios reveal a company’s ability to generate profits.

Ratio                                                                     Method of calculation

Gross Profit Margin (%)                                Gross profit x 100 / sales

Net profit Margin (%)                                     Net profit x 100 / sales

Return of Capital Employed (%)               Net profit x 100 / capital+P&L+Loan

Apply / Practice 

Liquidity - These ratios assess a company’s ability to meet its short-term debts.

Ratio                                                          Method of calculation

Current ratio                     Current assets/current liabilities

Acid test                             Current assets – closing stock /current liabilities

Apply / Practice 

Performance - These ratios assess how efficiently a company utilises its assets

Ratio                                                                                   Method of calculation

Stock turnover                                                                    Average stock/Cost of sales x 365

(days)       

    

Debtor/receivables collection period                            Debtors x 365 / sales income

(days) ideal (30 days)

Creditors/payables payment period                           Creditors x 365 / cost of sales

(days) ideal (40-50 days)

Apply / Practice 

Consolidate elements of.....

Profit and Loss 

Balance sheet 

Ratio analysis 

Assignment 

60% of module 

To complete today:

1. Calculate eight ratios 
2.  Description of the eight ratios
3. Describe benefits and limitations of ratio analyis

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Glaize video 

Would you invest in Glaize Nails?

Yes

No

Explain the reason for your choice. Would you invest for a different % of the business?

Which ratio would the Dragons be most interested in?

1. Current
2. Acid test
3. Rate of stock turnover
4. Return on capital employed

Now how do you feel about ratio analysis?

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Is there anything you need more help with regarding MFP?

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Plan for next week 

Break even analysis