Gauge of company performance/strength * Investment analysts are primarily interested in financial statements as a predictor of future performance * Lenders will primarily focus on the financial strength (default risk)
Financial Ratios
Margin Ratios
Gross profit margin = (Revenue – COGS) / Revenue
Net profit margin = Net profit after taxation / Revenue Should minority interest be added back to profit?
Net operating margin = Net profit before interest and tax / Revenue
Return on Investment Ratios
Return on capital employed (ROCE) = net profit / share capital + reserves + long-term liabilities Shows how much a company has earned on invested long-term funds.
Return on equity (ROE) = net profit / share capital + reserves Measures how much a company has earned on the funds invested by its shareholders.
Return on assets (ROA) = Net profit after tax + (interest x (1- tax rate))/ Total assets Shows how well a company’s funds were used, irrespective of the relative magnitudes of the sources of these funds
Earnings per share (EPS) = net profit / number of shares Diluted EPS includes potential shares (convertible bonds etc.)
Price to earnings (P/E) ratio = market price per share / EPS Reflects how the market judges the company’s growth expectations.
Asset Utilisation Ratios
* Total asset turnover = Revenue / total assets
* Long-term asset turnover= Revenue / non-current assets
* Inventory turnover = cost of sales / average inventory How many times a company's inventory is sold and replaced over a period Divide 365 by the answer to get the ‘average days inventory outstanding’
Solvency Ratios
Solvency refers to the long-term ability to generate cash internally or from external sources in order to meet long-term financial obligations
* Gearing ratio = Long-term liabilities / Capital employed
How dependent is a firm on borrowing? How much is it leveraged? More leverage is associated with more risk. Leverage