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Lecture Framework of financial reporting - Lecture 27

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The main contents of the chapter consist of the following: Interpreting financial statements, profitability ratios, operating profit margin (net profit) ratio, ROCE ratio, liquidity and working capital ratios, working capital ratios, current ratio or working capital ratios,. | Revise lecture 27 1 Interpreting financial statements 2 Interpreting financial information Profitability ratios Liquidity and working capital ratios Long term financial stability Investors ratios Limitations of financial statements and ratio analysis Related parties 3 Profitability ratios Gross profit margin or percentage is Gross profit / Sales revenue * 100% This is the margin that the company makes on its sales, and would be expected to remain reasonably constant. 4 Operating profit margin (net profit) ratio Can be calculated as: PBIT / Sales revenue * 100% Any changes in operating profit margin should be considered further: Are they in line with changes in gross profit margin? Are they in line with changes in sales revenue? 5 Operating profit margin (net profit) ratio 3. As many costs are fixed they need not necessarily increase/decrease with a change in revenue. 4. Look for individual cost categories that have increased/decreased significantly. 6 ROCE ratio ROCE = Profit / capital employed * 100% Profit is measured as: Operating (trading) profit, or The profit before interest and tax (PBIT) Capital employed is measured as: Equity + interest bearing finance 7 ROCE ratio ROCE for the current year should be compared to: The prior year ROCE A target ROCE The cost of borrowing Other companies ROCE in the same industry 8 Net asset turnover Sales revenue / Capital employed (net assets) = times pa It measures management’s efficiency in generating revenue from the net assets at its disposal The higher, the more efficient 9 Liquidity and working capital ratios 10 Working capital ratios There are two ratios used to measure overall working capital: The current ratio The quick or acid test ratio 11 Current ratio or Working capital ratios Current ratio or working capital ratio = Current assets / current liabilities :1 The current ratio measures the adequacy of current assets to meet the liabilities as they fall due. Traditionally, a current ratio of 2:1 or higher was . | Revise lecture 27 1 Interpreting financial statements 2 Interpreting financial information Profitability ratios Liquidity and working capital ratios Long term financial stability Investors ratios Limitations of financial statements and ratio analysis Related parties 3 Profitability ratios Gross profit margin or percentage is Gross profit / Sales revenue * 100% This is the margin that the company makes on its sales, and would be expected to remain reasonably constant. 4 Operating profit margin (net profit) ratio Can be calculated as: PBIT / Sales revenue * 100% Any changes in operating profit margin should be considered further: Are they in line with changes in gross profit margin? Are they in line with changes in sales revenue? 5 Operating profit margin (net profit) ratio 3. As many costs are fixed they need not necessarily increase/decrease with a change in revenue. 4. Look for individual cost categories that have increased/decreased significantly. 6 ROCE ratio ROCE = Profit / .