Ratio Analysis
Ratio Analysis
Ratio Analysis
Purpose:
To identify aspects of a businesses performance to aid decision making
Quantitative process ? may need to be supplemented by qualitative factors to get a complete picture
5 main areas:
Ratio Analysis
Liquidity ? the ability of the firm to pay its way
Investment/shareholders ? information to enable decisions to be made on the extent of the risk and the earning potential of a business investment
Gearing ? information on the relationship between the exposure of the business to loans as opposed to share capital
Profitability ? how effective the firm is at generating profits given sales and or its capital assets
Financial ? the rate at which the company sells its stock and the efficiency with which it uses its assets
Liquidity
Acid Test
Also referred to as the ?Quick ratio'
(Current assets ? stock) : liabilities
1:1 seen as ideal
The omission of stock gives an indication of the cash the firm has in relation to its liabilities (what it owes)
A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it owes ? very healthy!
A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash to pay for those liabilities. This might put the firm under pressure but is not in itself the end of the world!
Current Ratio
Looks at the ratio between Current Assets and Current Liabilities
Current Ratio = Current Assets : Current Liabilities
Ideal level? ? 1.5 : 1
A ratio of 5 : 1 would imply the firm has £5 of assets to cover every £1 in liabilities
A ratio of 0.75 : 1 would suggest the firm has only 75p in assets available to cover every £1 it owes
Too high ? Might suggest that too much of its assets are tied up in ...