Ratio Analysis

Ratio Analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and
profitability by comparing information contained in its financial statements. This analysis involves calculating
various financial ratios — like profitability, liquidity, efficiency, and leverage ratios — and interpreting them to
understand the financial health and performance of a business.
Ratio analysis is a study about accounting ratios among various items included in the balance sheet and income
statement. These ratios include asset utilization ratios, efficiency ratios, profitability ratios, leverage ratios,
liquidity ratios, and valuation ratios.
Advantages
1. It simplifies the financial statements.
2. It helps in comparing companies of different size with each other.
3. It helps in trend analysis which involves comparing a single company over a period.
4. It highlights important information in simple form quickly.
5. It helps the users to make investment decisions.
6. It shows the overall picture and trading position of the company.
7. It is easy to calculate and simple to understand.
Limitations
1. Misleading comparison due to different environmental conditions (e.g. regulations, market structures).
2. Accounting standards allow different accounting policies, which impairs comparability.
3. Ratio analysis explains relationships between past information while users are more concerned about current
and future information.
4. Bench marking ratios is difficult as different firms operate in different environmental conditions.
5. Some ratios are based upon PL and BS both items such as ROCE, ROE and ATO. PL shows the value of a
particular period of time whereas BS shows the value of a particular point of time. The comparisons may get
invalid. We need to make the averages of balance sheet figures which is a difficult task.
6. Decision making on the results of past data might not be effective.

Question 1 (COMPREHENSIVE ANALYSIS)

The following data relates to Roddick PLC for the year 2020 & 2021. Prepare financial analysis for the company:

INCOME STATEMENT 2020 ($) 2021 ($)

Revenue 5435 7180
Cost of sales -4212 -5385
Gross profit 1223 1795
Administrative expenses -507 -670
Distribution costs -254 -335
Profit from operations 462 790
Finance costs -52 -50
Profit before tax 410 740
Taxation -144 -262
Profit for the year (PAT) 266 478
Dividends -95 -169
Retained profits for the year 171 309
OTHER INFORMATION
Market price per share 5 6
Capital Employed 1801 2690
Net working capital 975 1349
SOFP 2020 ($) 2020 ($) 2021 ($) 2021 ($)
Non-current assets 826 1341
Current assets

Inventory 871 1006

Receivables 708 948
Cash at bank 100 1679 360 2314
TOTAL ASSETS 2505 3655
Equity
Equity shares ($1 each) 720 1200
Retained earnings 681 1401 990 2190
Non-current liabilities
10% debentures 400 500
Current liabilities
Payables 516 653
Tax 140 228
Accruals 48 704 84 965
Total equity &liabilities 2505 3655

Answer
RATIO NAME FORMULA 2020 2021
PROFITABILITY
Gross profit margin Gross profit / sales x 100 22.5023 25.0000
Net profit margin PAT/ sales x 100 4.8942 6.6574
Operating profit margin operating profit / sales x 100 8.5005 11.0028
Return on capital employed operating profit / capital employed x100 25.65242 29.36803
Return on equity PAT/ Equity x 100 18.98644 21.82648
Return on assets PAT/ASSETS X 100 10.61876 13.07798
RESOURCE UTILIZATION
Assets turnover Sales/ Assets 2.169661 1.964432
Net assets turnover Sales/Net assets 3.879372 3.278539
Capital employed turnover Sales/CE 3.017768 2.669145
WORKING CAPITAL
Inventory days Closing inventory/COS x 365 75.4784 68.18756
Receivable days Receivables/Sales x 365 47.54738 48.1922
payable days Payables/COS x 365 44.7151 44.26091
Working Capital Cycle Inventory days + Receivable days - Payable days 78.31067 72.11885
LIQUIDITY
Current ratio Current assets/ Current liabilities 2.384943 2.397927
Quick ratio (Current assets - Closing stock)/ Current Liabilities 1.147727 1.35544
FINANCIAL RISK
Debt to Equity ratio Debt/ Equity x 100 28.55103 22.83105
Debt to Capital ratio (Gearing) Debt/CE x 100 22.20988 18.58736
Interest cover (earning method) Operating profit/finance expense 8.884615 15.8
INVESTOR & MARKET RATIOS
Earnings per share (EPS) PAT/ Number of ordinary shares 0.369444 0.398333
Dividend per share (DPS) Dividends/ Number of shares 0.131944 0.140833
Dividend Cover PAT/ Dividends 2.8 2.828402
Price Earnings ratio (PER) MPS/EPS 13.53383 15.06276
Earning Yield EPS/MPS x 100 7.388889 6.638889
Dividend Yield DPS/MPS x 100 2.199074 2.347222

Financial Analysis
Gross Profit Margin
Definition: Gross profit margin is the percentage of revenue that exceeds the cost of goods sold. It indicates the
efficiency in managing production or service delivery costs.
Performance: An increase from 22.5023% in 2020 to 25.0000% in 2021 indicates improved efficiency, either
through better control over costs or increased pricing power.
Universal Standard: Higher values are generally better, indicating more efficient management, though the 'good'
percentage can vary by industry.
Net Profit Margin
Definition: The net profit margin indicates, for every $1 of sales made, how much is left as profit once all costs
have been incurred (including interest and tax expenses). It measures overall profitability.
Performance: An increase from 4.8942% in 2020 to 6.6574% in 2021 suggests Roddick Limited has become more
efficient in its operations, leading to higher profitability.
Universal Standard: The higher this percentage, the more a company appears to be able to control costs
compared to the premium charged on sales Higher is typically better, but the ideal percentage varies by industry.
Operating Profit Margin
Definition: This ratio measures the percentage of revenue left after deducting operating expenses. It reflects the
efficiency of core business operations.
Performance: The increase from 8.5005% to 11.0028% indicates improved operational efficiency or an increase in
revenue from core operations.
Universal Standard: Like other profitability ratios, higher is generally better, with standards varying by industry.
Return on Capital Employed (ROCE)
Definition: ROCE measures the company’s profitability and the efficiency with which its capital is employed. It
indicates how well the company generates profits from its total capital.
Performance: An increase from 25.65242% to 29.36803% suggests more efficient use of capital in generating
profits.
Universal Standard: Higher ratios are better, indicating efficient use of capital, but optimal values depend on
industry norms.
Return on Equity (ROE)
Definition: Using accounting measures, this relationship gives an indication of how much return is being
generated for shareholders compared to the finance which equity investors have invested in the company.
It is useful to compare this from year to year to see if a company is using equity finance wisely and offering
growth. Alternatively, this value can be compared with other companies to indicate whether the first company
offers better returns than competition within the same industry.
Investors can also look at this metric to see if it meets their own minimum requirement when compared to the
risk taken on investing in such a company
Performance: The increase from 18.98644% to 21.82648% means that the company is providing better returns to
its shareholders.
Universal Standard: Higher ratios are favorable, showing effective management and profitability. However,
extremely high values might indicate excessive leverage.
Return on Assets (ROA)
Definition: ROA shows how profitably a company uses its assets. It measures the efficiency of asset management
in generating profits.
Performance: The growth from 10.61876% to 13.07798% suggests that Roddick Limited is using its assets more
efficiently to generate earnings.
Universal Standard: Higher values are generally seen as positive, indicating efficient use of assets. The ideal ratio
can vary significantly across different industries.
Asset Turnover
Definition: The asset turnover gives an indication of the success a company can have in utilising its assets to
generate sales. This ratio measures a company's ability to generate sales from its assets. Higher values indicate
more efficient use of assets.
Performance: A decrease from 2.169661 in 2020 to 1.964432 in 2021 suggests a slight decline in efficiency in
using assets to generate sales.
Universal Standard: The higher the number, the more sales the company is able to generate from every $1
invested in assets. The ideal number varies industry to industry.
Net Asset Turnover
Definition: This ratio indicates how effectively a company uses its net assets to generate sales revenue.
Performance: A decrease from 3.879372 to 3.278539 indicates a reduced efficiency in using net assets to
generate sales.
Universal Standard: Higher values are preferred, though the optimal ratio varies by industry.
Capital Employed Turnover
Definition: This measures how efficiently the company’s capital employed is being used to generate revenue.
Performance: Decreasing from 3.017768 to 2.669145 suggests a lower efficiency in using capital employed.
Universal Standard: Higher values are generally better, indicating more efficient use of capital.

Inventory Days
Definition: This ratio gives an indication of how long a firm takes to sell an ‘average’ item of inventory. It
indicates the average number of days items remain in inventory before being sold.
Performance: A decrease from 75.4784 to 68.18756 days suggests an improvement in inventory management.
Universal Standard: Shorter numbers indicate that a firm is effectively turning over inventory more quickly and is
therefore being more efficient with its resources.
Receivable Days
Definition: This measures the average number of days it takes for a company to receive payments from its
customers.
Performance: An increase from 47.54738 to 48.1922 days indicates a slight slowdown in collecting receivables.
Universal Standard: Lower is generally better, indicating faster collection of receivables.
Payable Days
Definition: This shows the average number of days a company takes to pay its suppliers.
Performance: A slight decrease from 44.7151 to 44.26091 days.
Universal Standard: It could be argued that the longer this ratio is, the more effectively a company is managing its
working capital. This is because, the longer this period is, the longer finance is retained inside the business before
being used to settle a liability. But it can high can harm supplier relationships.

Working Capital Cycle (Days)

Definition: This measures the time taken for a company to turn its net working capital into cash. It's the sum of
inventory and receivable days minus payable days.
Performance: A decrease from 78.31067 to 72.11885 days suggests an improvement in managing the working
capital cycle.
Universal Standard: Lower is typically better, indicating a more efficient cash conversion process.
Current Ratio
Definition: This ratio measures a company’s ability to pay short-term obligations with short-term assets.
Performance: A slight increase from 2.384943 to 2.397927.
Universal Standard:
Good Acceptable Weak
Above 2 Between 1 & 2 Below 1

Quick Ratio
Definition: Similar to the current ratio but excludes inventory from assets.
Performance: An increase from 1.147727 to 1.35544 suggests better short-term financial health.
Universal Standard:
Good Acceptable Weak
Above 1 Between 1 & 0.50 Below 0.5
Debt to Equity Ratio
Definition: This ratio compares a company's total liabilities to its shareholder equity.
Performance: A decrease from 28.55103% to 22.83105% suggests a healthier balance between debt and equity.
Universal Standard: Lower ratios are typically seen as less risky, but this can vary by industry.
Low Financial Risk Acceptable Financial Risk High Financial Risk
Up to 80% Between 80% - 100% Above 100%

Debt to Capital Ratio (Gearing)

Definition: This ratio measures the financial leverage of a company by comparing its debt to its total capital.
Performance: A decrease from 22.20988% to 18.58736% indicates less reliance on debt financing.
Universal Standard: Lower ratios are generally seen as less risky.
Low Financial Risk Acceptable Financial Risk High Financial Risk
Up to 40% Between 40% - 50% Above 50%

Interest Cover (Earning-Method)

Definition: This ratio measures a company's ability to meet its interest obligations from its operating profits.
Performance: An increase from 8.884615 to 15.8 indicates a stronger ability to cover interest expenses.
Universal Standard: Generally, a higher ratio is considered safer.
Low Financial Risk Acceptable Financial Risk High Financial Risk
Above 3 Between 1-3 Below 1

Interest Cover (Cash Flow-Method)

Definition: Similar to the above but measures the ability to cover interest from operating cash flow (cash
generated from operations).
Performance: An increase from 4.519231 to 5.28 suggests improved cash flow management.
Universal Standard: Higher values are preferred, indicating stronger liquidity and less exposure to financial risk.
Earnings per Share (EPS)
Definition: This is a key metric which allows investors to see the magnitude of return they obtain for each
individual share they own. This measures the portion of a company's profit allocated to each outstanding
share.US GAAP and IFRS require listed entities to calculate and present this value on the face of the income
statement.
Performance: An increase from 0.369444 to 0.398333 indicates higher profitability per share.
Universal Standard: Higher is generally better, indicating greater profitability per share.
Dividend per Share (DPS)
Definition: This shows the dividend paid out per share.
Performance: An increase from 0.131944 to 0.140833 suggests higher returns to shareholders.
Universal Standard: Higher values may be attractive to investors, but sustainability is key.
Dividend Cover
Definition: This ratio measures a company's ability to pay dividends out of its profits.
Performance: A slight increase from 2.8 to 2.828402 indicates a stable dividend payout.
Universal Standard: Higher values indicate more easily sustainable dividends.
Good Acceptable Weak
Above 2 Between 1-2 Below 1
Price Earnings Ratio (PER)
Definition: This ratio compares a company's share price to its earnings per share. It gives an indication of how
much investors are willing to pay for $1 of current earnings. For example, a PE ratio of 9 suggests investors are
willing to pay $9 today for $1 of current earnings. This is an indicator that investors see potential in future
earnings. The higher the metric, the more the markets must believe the company’s future holds good prospects
Performance: An increase from 13.53383 to 15.06276 suggests higher market valuation relative to earnings.
Universal Standard: Higher value is preferred. But the optimal value varies by industry and market conditions.
Earning Yield
Definition: This allows investors to see the proportional return a company is generating compared with the value
tied up within the share. Although a company may have a growing EPS, if the share price is outgrowing this, then
the yield will be dropping.
This relative measure may therefore be more insightful and a better metric to compare from company to
company.
Performance: A decrease from 7.388889% to 6.638889%.
Universal Standard: Higher values indicate potentially undervalued stocks or higher earnings relative to share
price.
Dividend Yield
Definition: From dividend yield investors can see how much they are likely to obtain in cash terms from having an
investment in a company. This ratio shows how much a company pays out in dividends each year relative to its
share price.
Performance: An increase from 2.199074% to 2.347222% suggests higher returns for shareholders.
Universal Standard: Higher values are attractive to income-focused investors, but sustainability is important.
Overall Financial Performance and Position:
Based on these ratios, Roddick Limited appears to have improved its financial performance from 2020 to 2021.
The company shows increased efficiency in managing costs and generating profits from its operations, capital,
equity, and assets. This trend suggests strong operational management and a potentially solid financial position in
the market. Overall profitability position has got better. While there are signs of improved efficiency in some
areas (like inventory management), there are also indicators of reduced asset utilization efficiency. The company
has improved its liquidity and reduced its debt relative to equity, suggesting a stronger financial position. The
increased interest coverage ratios indicate better profitability and ability to meet financial obligations. The slight
changes in earnings and dividend per share reflect a stable yet growing profitability and shareholder return.
Overall, Roddick PLC seems to be managing its finances well, with room for improvement in certain areas of asset
utilization.
QUESTION 2 (COMPREHENSIVE QUESTION)
The following data relates to COLERIDGE PLC for the year 2020 & 2021. Prepare financial analysis for the company:

COLLERIDGE PLC
INCOME STATEMENT 2020 ($) 2021 ($)
Revenue 210619 206470
Cost of sales 141789 121198
Gross profit 68830 85272
Operating expenses 47610 41459
Profit from operations 21220 43813
Finance costs 0 3000
Profit before tax 21220 40813
Taxation 3180 6100
Profit for the year (PAT) 18040 34713
Dividends 13000 2000
Retained profits for the year 5040 32713

BALANCE SHEET 2020 ($) 2021 ($)

Non-Current Assets 68750 129490
 Inventory 14550 14278
Receivables 29420 20693
BANK 640 10792
TOTAL CURRENT ASSETS 44610 45763
TOTAL ASSETS 113360 175253
Capital ($1) 20000 20000
Retained Earnings 77070 109783
Equity 97070 129783
Long term Loans 0 30000
Current Liabilities 16290 15470
Total Liabilities 16290 45470
Total Liabilities & Equity 113360 175253
Other information
MPS 4 5
Capital employed 97070 159783
NET WORKING CAPITAL 28320 30293
ANSWER

CALCULATION OF RATIOS
RATIO NAME FORMULA 2020 2021
PROFITABILITY
Gross profit margin (%) Gross profit / sales x 100 32.67986 41.29995
Net profit margin (%) PAT/ sales x 100 8.565229 16.81261
Operating profit margin (%) operating profit / sales x 100 10.07506 21.22003
Return on capital employed (%) operating profit / capital employed x100 21.86051 27.42031
Return on equity (%) PAT/ Equity x 100 18.58453 26.74695
Return on assets (%) PAT/ASSETS X 100 15.9139 19.80736
RESOURCE UTILIZATION
Assets turnover (times) Sales/ Assets 1.857966 1.178125
Net assets turnover (times) Sales/Net assets 2.169764 1.590886
Capital employed turnover (times) Sales/CE 2.169764 1.29219
WORKING CAPITAL RATIOS
Inventory days Closing inventory/COS x 365 37.4553 42.99964
Receivable days Receivables/Sales x 365 50.98448 36.58132
payable days Payables/COS x 365 41.93449 46.58947
Working Capital Cycle (days) Inventory days + Receivable days - Payable days 46.50529 32.99149
LIQUIDITY RATIOS
Current ratio (times) Current assets/ Current liabilities 2.73849 2.958177
Quick ratio (times)
(Current assets - Closing stock)/ Current Liabilities 1.845304 2.035229
FINANCIAL RISK
Debt to Equity ratio (%) Debt/ Equity x 100 0 23.11551
Debt to Capital ratio (%) Debt/CE x 100 0 18.77546
Interest cover (earning method) Operating profit/finance expense 0 14.60433
INVESTOR & MARKET RATIOS
Earnings per share (EPS) (times) PAT/ Number of ordinary shares 0.902 1.73565
Dividend per share (DPS) (times) Dividends/ Number of shares 0.65 0.1
Dividend Cover (times) PAT/ Dividends 1.387692 17.3565
Price Earning ratio (PER) (times) MPS/EPS 4.43459 2.880765
Earning Yield (%) EPS/MPS x 100 22.55 34.713
Dividend Yield (%) DPS/MPS x 100 16.25 2

COMMENTS
Analyzing Coleridge PLC's financial performance and position between 2020 and 2021 involves understanding the
interplay between various financial ratios. Let's examine these ratios and how they relate to each other:
Profitability Ratios
Gross, Net, and Operating Profit Margins: All these margins have increased significantly (Gross Profit Margin from
32.67986% to 41.29995%, Net Profit Margin from 8.565229% to 16.81261%, and Operating Profit Margin from
10.07506% to 21.22003%). This suggests that Coleridge PLC has become more efficient in managing its costs and
has likely improved its pricing strategy or sales mix.
Return on Capital Employed (ROCE), Return on Equity (ROE), and Return on Assets (ROA): These ratios also
increased (ROCE from 21.86051% to 27.42031%, ROE from 18.58453% to 26.74695%, and ROA from 15.9139% to
19.80736%), indicating better utilization of capital, equity, and assets in generating profits.
Efficiency Ratios
Asset Turnover Ratios: There is a notable decrease in Assets Turnover (from 1.857966 to 1.178125), Net Assets
Turnover (from 2.169764 to 1.590886), and Capital Employed Turnover (from 2.169764 to 1.29219). This
decrease suggests that while the company is more profitable, it is generating less revenue per unit of assets or
capital employed.
Inventory, Receivable, and Payable Days: Inventory days increased (from 37.4553 to 42.99964), indicating slower
inventory turnover. Receivable days decreased (from 50.98448 to 36.58132), showing improved efficiency in
collecting receivables. Payable days increased (from 41.93449 to 46.58947), suggesting the company is taking
longer to pay its suppliers.
Working Capital Cycle: The working capital cycle decreased (from 46.50529 to 32.99149 days), indicating a more
efficient use of working capital.
Liquidity Ratios
Current and Quick Ratios: Both ratios increased (Current Ratio from 2.73849 to 2.958177, Quick Ratio from
1.845304 to 2.035229), suggesting an improvement in the company's short-term liquidity position.
Leverage Ratios
Debt to Equity and Debt to Capital Ratios: These ratios went from 0 in 2020 to 23.11551% and 18.77546% in
2021, respectively. This change indicates that the company has taken on debt, moving away from a completely
equity-financed structure.
Interest Cover: This ratio increased from 0 to 14.60433, which suggests that the newly acquired debt has not
adversely impacted the company's ability to cover its interest expenses, likely due to increased profitability.
Investment Ratios
Earnings PER Share (EPS) and Dividend Per Share (DPS): EPS increased significantly (from 0.902 to 1.73565), while
DPS decreased (from 0.65 to 0.10), suggesting that the company is retaining more earnings, possibly for
reinvestment.
Dividend Cover: Increased dramatically (from 1.387692 to 17.3565), further indicating that a higher proportion of
earnings is being retained rather than distributed as dividends.
Price Earnings Ratio (PER) and Earning Yield: PER decreased (from 4.43459 to 2.880765), and Earning Yield
increased (from 22.55% to 34.713%), suggesting the market is valuing the company's earnings more favorably.
Dividend Yield: Decreased significantly (from 16.25% to 2.00%), reflecting the lower dividends paid in relation to
the company's share price.
Overall Analysis
From 2020 to 2021, Coleridge PLC has shown a remarkable improvement in profitability, indicating more efficient
operations and better cost management. The decrease in asset and capital turnover ratios, alongside an
increased working capital cycle, could suggest a strategic shift towards higher margin, lower volume sales, or
changes in the asset base. The introduction of debt into the capital structure is a significant change but seems to
be well managed, given the high interest cover ratio. The shift in dividend policy, as reflected by lower DPS and
higher dividend cover, along with increased EPS, suggests a focus on reinvesting profits into the business,
potentially for growth or debt servicing. The overall picture is one of a company that has become more profitable
and efficient, though with a shift in its approach to revenue generation, asset management, and financial
structure.
EXAM TYPE QUESTIONS
QUESTION 1
ANSWER
QUESTION 2
Answer
QUESTION 3
ANSWER