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FinancialperformanceAppraisalofCompanyAccountsusingRatiosWhatismeantbyinterpretation?•Lookingattheaccountsandthenotestotheaccounts–astheyare•Makingafewsimplecalculations•MakinginformedjudgementsAPPRAISALOFACCOUNTS•1.Profitability-theabilityofafirmtouseitsassetbaseinordertoincreasethetotalassets.•2.Solvency/Liquidity-Thisreferstotheabilityofafirmtopayoffitsshort-termdebts•3.Efficiency-theefficiencywithwhichthefirmmanagesitscurrentassetsandcurrentliabilities•4.Capitalstructure-Thisassesstheabilitytomeetlong-termfinancialobligations.RATIOANALYSIS•COMPARATIVESAREHELPFUL–WITHPREVIOUSYEARS–WITHBUDGETS&FORECASTS–WITHSIMILARCOMPANIES–WITHMACROECONOMICCONDITIONS5Example1:Crosssectionalcomparison1.Comparisonsbetweenentities–whichofthefollowingcompaniesisthemostprofitable?ProfitNetassetsCo.A£’000200500Co.B£’0001,00010,0003Return40%10%Example2:Timeseriescomparison2.Hastherebeenanincreaseordecreaseinprofitabilityfromoneyeartothenext?ProfitNetassetsPreviousyear£’0009008,000Currentyear£’0001,00010,0004Return11.25%10%Profitability•RETURNONCAPITALEMPLOYED(ROCE)Generallysomesortofmeasureofprofitasapercentageofcapitalinabusiness:•R.O.C.E.=PROFITBEFOREINTERESTANDTAX/TOTALASSETS-CURRENTLIAB.6INCOMESTATEMENT£000Salesrevenue34,800Costofsales22,400GrossProfit12,400Operatingexpenses8,020Operatingprofit4,380Interestpaid40Profitbeforetax4,340Taxation890Profitaftertax3,450ABCPLC7BALANCESHEET£000Non-currentassets29,455Currentassets6,250TotalAssets35,705Equity&LiabilitiesOrdinaryshares12,000Preferenceshares1,000Retainedearnings19,69232,692Less:non-currentliabilities554Less:currentliabilities2,459TotalEquity&Liabilities35,705BALANCESHEET£000Non-currentassets29,455Currentassets6,250TotalAssets35,705Equity&Liabilities12,000OrdinarysharesPreferenceshares1,00019,692Retainedearnings32,692Less:non-currentliabilities554Less:currentliabilities2,459TotalEquity&Liabilities35,705INCOMESTATEMENT£000Salesrevenue34,800Costofsales22,400GrossProfit12,400Operatingexpenses8,020Operatingprofit4,380Interestpaid40Profitbeforetax4,340Taxation890Profitaftertax3,450ROCE=4380/33246=13.2%ROCEEXAMPLE8ProfitabilityPROFITMARGINSGenerallysomesortof%measureofprofitfromactivity.GROSSPROFITMARGIN(%)=GROSSPROFIT/SALESNETPROFITMARGIN(%)=OPERATINGPROFIT(PBIT)/SALES10GrossProfitPercentageFactorsnegativelyaffectingthisratio:I.Adecreaseinsales.II.Anincreaseinthepurchasingprice(perhapsasaresultofchangingsupplierornottakingadvantageofdiscounts)III.Achangeinthesellingpriceoreffectsofcompetition(insomecasescompaniesmarkdownthepriceinordertodisposeofslowmovingorobsoletestock).GrossProfitPercentageFactorsnegativelyaffectingthisratio:IV.AchangeinthesalesmixwherelineswhicharenotasprofitablearebeingcarriedV.Anincreaseinshrinkage–i.e.stocklossesresultingfromwastage,breakagesortheftNetprofitmargin•Thisratioshowshowprofitableabusinessisafterallexpenseshavebeentakenintoaccount.•Changes:•1.Costofsalesincreased•2.Administrativeexpensesanddistributioncostsincreased•3.SalesstrategyBALANCESHEET£000Non-currentassets29,455Currentassets6,250TotalAssets35,705Equity&LiabilitiesOrdinaryshares12,000Preferenceshares1,000Retainedearnings19,69232,692Less:non-currentliabilities554Less:currentliabilities2,459TotalEquity&Liabilities35,705INCOMESTATEMENT£000Salesrevenue34,800Costofsales22,400GrossProfit12,400Operatingexpenses8,020Operatingprofit4,380Interestpaid40Profitbeforetax4,340Taxation890Profitaftertax3,450EXAMPLE11BALANCESHEET£000Non-currentassets29,455Currentassets6,250TotalAssets35,705Equity&LiabilitiesOrdinaryshares12,000Preferenceshares1,000Retainedearnings19,69232,692Less:non-currentliabilities554Less:currentliabilities2,459TotalEquity&Liabilities35,705INCOMESTATEMENT£000Salesrevenue34,800Costofsales22,400GrossProfit12,400Operatingexpenses8,020Operatingprofit4,380Interestpaid40Profitbeforetax4,340Taxation890Profitaftertax3,450GPmargin=12400/34800=35.6%GPMARGINEXAMPLE12BALANCESHEET£000Non-currentassets29,455Currentassets6,250TotalAssets35,705Equity&LiabilitiesOrdinaryshares12,000Preferenceshares1,000Retainedearnings19,69232,692Less:non-currentliabilities554Less:currentliabilities2,459TotalEquity&Liabilities35,705INCOMESTATEMENT£000Salesrevenue34,800Costofsales22,400GrossProfit12,400Operatingexpenses8,020Operatingprofit4,380Interestpaid40Profitbeforetax4,340Taxation890Profitaftertax3,450GPmargin=4380/34800=12.6%NPMARGINEXAMPLE13LIQUIDITYRATIOS•‘Liquidity’referstotheabilityofabusinesstogeneratesufficientcashtopayitsliabilitiesastheyfalldueforpayment.•Itislinkeddirectlytotheshort-termsolvencyofabusiness.•Abusinessgoesbustwhenitcannotpayitsdebts(itbecomesinsolvent).19CURRENTRATIO•=TOTALCURRENTASSETS/TOTALCURRENTLIABILITIES•RELEVANCETOCASHFLOW•GUIDETOADEQUACY–amagicfigure?–dependsonrealisationofstockandcollectionofdebtors.21INCOMESTATEMENT£000Salesrevenue34,800Costofsales22,400GrossProfit12,400Operatingexpenses8,020Operatingprofit4,380Interestpaid40Profitbeforetax4,340Taxation890Profitaftertax3,450ABCPLC7BALANCESHEET£000Non-currentassets29,455Currentassets6,250TotalAssets35,705Equity&LiabilitiesOrdina