Ratios and Strategy

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Accounting Ratios

In your exam, you may be required to calculate some ratios.

This section shall only present a summary and list of ratios that could potential be used in your exam for such purpose.

Ratios may be divided into the following categories:

  • PROFITABILITY RATIOS

    These are measures of value added being generated by an organisation and include the following:

  • ROCEOperating Profit (PBIT)/Capital Employed
    Capital EmployedEquity + LT liabilities
    Capital EmployedNon current assets + net current assets
    Capital EmployedTotal assets - current liabilities
    Gross marginGross Profit/Sales
    Net MarginNet Profit/Sales
    ROEProfit After Tax - Preference dividends/Shareholders’ Funds (Ordinary shares + Reserves)
    RIProfit After Tax - (Operating Assets x Cost of Capital)
  • EFFICIENCY RATIOS

    These are measures of utilisation of Current & Non-current Assets of an organisation.  Efficiency Ratios consist of the following:

  • Asset TurnoverSales/Capital Employed
    ROCEMargin X Asset Turnover
    Receivables Days(Receivables Balance / Credit Sales) x 365
    Payables Days(Payable Balance / Credit Purchases) x 365
    Inventory Days(Inventory / Cost of Sales) x 365
  • LIQUIDITY & GEARING RATIOS

    Liquidity Ratios measure the extent to which an organisation is capable of converting assets into cash and cash equivalents.  

    On the other hand, Gearing Ratios measure the dependence of an organisation on external financing as against shareholder funds.  

    Liquidity and Gearing Ratios are outlined below:

  • Liquidity
    Current RatioCurrent Assets / Current Liabilities
    Quick Ratio(Current Assets – Inventory) / Current Liabilities
    Gearing
    Financial GearingDebt/Equity
    Financial GearingDebt/(Debt + Equity)
    Operational gearing Contribution / PBIT
  • INVESTOR'S RATIOS

    These ratios measures return on investment generated by stakeholders.  Such ratios include:

  • Dividend CoverProfit After Tax / Total Dividend
    Dividend YieldDividends per share / Share price
    Interest CoverPBIT / Interest
    Interest yield (coupon rate / market price) x 100%
    Earnings Per ShareProfit After Tax and preference dividends / Number of Shares
    PE RatioShare Price / EPS
  • In the exam you have to act like a detective.

    You have to sift through evidence and extract meaningful messages for effective business decisions.

    The starting point is often the basic accounting documents that record the progress of any business, the Income statement & SFP

    These are closely related  and so need reading together.

    The balance sheet is a snapshot of a business at one point in time.

    The income statement is dynamic and describes the flow of money through the business over a period of time.

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