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Unit 3 Accounts & Finance

Unit 3 Accounts & Finance. Ratio Analysis. Learning Objectives. To be able to calculate ratios To be able to use ratios to interpret and analyse financial statements from the perspective of various stakeholders

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Unit 3 Accounts & Finance

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  1. Unit 3 Accounts & Finance Ratio Analysis

  2. LearningObjectives • To be able to calculate ratios • To be able to use ratios to interpret and analyse financial statements from the perspective of various stakeholders • HL – To evaluate the possible financial and other strategies to improve the values of ratios

  3. Accounting Ratios Five main groups of ratios • Profitability ratios • Gross Profit Margin • Net Profit Margin • ROCE • Mark-up • Liquidity ratios • Current Ratio • Acid Test Ratio • Financial efficiency ratios • Stock (inventory) Turnover Ratio • Debtor Days Ratio • Creditor Days Ratio • Shareholder or investment ratios • Dividend Yield Ratio • Earnings per share ratio • Gearing ratios • Gearing Ratio Key word – Efficiency How well a firm is using its resources

  4. Financial Efficiency Ratios • Many different ratios • Two most frequently used are • Stock turnover ratio • Debtor days ratio

  5. Cost of goods sold STR Value of stock (average) Financial Efficiency Ratio • Stock (Inventory) Turnover Ratio • In principle, the lower the amount of capital used in holding stocks, the better • Modern stock control theory focuses on minimising investment in inventories (JIT) • This ratio records the number of times the stock of a business is bought in and resold in a period of time • Generally, the higher the ratio, the lower the investment in stocks will be

  6. Cost of goods sold STR Value of stock (average) Financial Efficiency Ratio • Stock (Inventory) Turnover Ratio • This ratio uses average stock holding • The average value of inventories at the start of the year and at the end • Alternative formula is Stock turnover ratio (days) = value of stocks cost of sales / 365

  7. Cost of goods sold STR Value of stock (average) Financial Efficiency Ratio • Stock (Inventory) Turnover Ratio • Result is not a % but the number of times stock turns over in the time period (usually a year) • The higher the number the more efficient the managers are in selling stock rapidly • Very efficient stock management will give a high inventory turnover ratio • Normal result for a business depends on the industry it operates in (fresh food higher ratio than car shop)

  8. Debtor Days Ratio • The debtor days ratio, also know as the debt collection period measure the number of days it takes a firm, on average, to collect money from its debtors, the shorter the time the better the management • Debtors are the customers who have purchased items on credit from the business and therefore owe money to the firm Trade debtors (accounts receivable) Sales turnover x 365 (days)

  9. Debtor Days Ratio • Can also be calculated using total credit sales, thus excluding sales for cash from the calculation – more accurate, as cash sales never lead to debtors • Results show how long a company gives its customers time to pay debts • No right o wrong result

  10. Debtor Days Ratio • For example, if a firm’s debtors totals $1M whilst its turnover is $5M, then the ratio is 73 days • This means that on average, it takes the business 73 days to collect debts from its customers who have bought items on credit • Why is the lesser the time the better? • A business who has a low figure may have to be careful they are not losing out to other businesses who may be offering better credit terms • It is common for a business to allow customers 30-60 days credit so a ratio of between 30-60 would be acceptable • The period depends on the context of the business

  11. Improving debt collection period • Impose surcharges on late payments, e.g. banks utility companies • Give debtors incentives to pay earlier, such as a discount before the due date • Direct debit • Refuse any further business with a client until payment is made • Threaten legal action

  12. Creditor Days Ratio • Measures the number of days it takes, on average, for a business to pay its creditors (suppliers) Trade Creditors Creditor purchases x 365 • E.g. if a firm has $225,000 owed to its suppliers with £1.75M worth of cost of sales, the creditor days is 47 days • This means on average it takes a business 47 days to pay its suppliers • In general the higher this figure the better for the business as it means repayment terms are prolonged • If it is too high however suppliers may impose financial penalties for late payment

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