Ratio's provide for a very simple and effective method for
looking at the financial performance o any business by analysing the financial
accounts of the business.
You are simply looking at what the business owns (its assets) against
what the business currently owes (it's liabilities). In an ideal world any
business should have at least twice the amount of assets to cover paying
for it's debts.
In this ratio, the assets are looked into as not including stock, the
logic being your business may not be able to sell everything it makes, if
there is no longer any demand for it's products. The results may well show
that a business is not able to meet all it's debts if there is no demand
for it's products, this is a worse case pessimistic model. The overall
figure will generally show a figure of 1 to 1.
This model simply looks at actual stock and then divides it against the
cost of sales (purchases) against days in a year to show how many times
the stock will be used over a year.
This model looks at how much the business is owed against the sales
figure against the number of days in the year to show how long it would
take for the business to receive the money it is owed by it's customers.
This model observes how much the business owes its creditors, and it
shows how long the business would on current performance take to pay it's
suppliers.
This model shows that sales in relation to capital employed should
equal the amounts of sales in relation to the net assets of a business,
the premise being that money invested in a business will be equal to the
assets it owns.
This model shows the return on money invested in the business. The
capital employed figure would come from looking looking at Fixed Assets
adding Current assets minus Creditors (see balance sheet section).
This model shows the profits of a business in relation to interest it
pays to banks/shareholder, the logic being at seeing how much business
profits are in relation to the overall business profits.
This model looks at what the current value of the business shares are
in relation to money given as dividends, often in the Financial Times,
this figure will be shown as the PE figure, it is merely a analysis
figure.
The most essential ratios for basic analysis would be:
The current ratio, to observe the basic state of the
business in terms of all current credit/debt.
Then you would look at how long it would take for business
customers to pay business debts against the period the business takes to pay
it's creditors, you would be using debtor and creditor turnover ratios,
ideally you would want a business to be paying it's creditors at a slower
rate than money coming into the business.
The gross and net profit ratios to see what the percentage
of sales figure are.
Finally to look at the performance of a business in terms of
dividend yield ratio to see the value of the dividends given against the
value of the shares.
Ratios can prove to be a valuable analysis tool, but they are
based on looking at accounts which are only true for one day in time.
If we look back at the earlier models of the Trading Profit
& Loss Account and Balance Sheet we can apply some ratio analysis to them,
as shown in the spreadsheet below: