Ratio Analyses is a tool used to measure the performance of a company based on the information provided in the financial statements. The results are compared against other companies in the industry, the industry in general or any predetermined targets set for the company. Ratios are also useful in tracking movements or trends in the financial data that could signify that critical changes in the company’s operations may be needed.
The following are the most frequently used financial ratios and the related calculations. A very brief analysis is included to help in understanding how the ratios may be interpreted.
- Operating Profit Margin:
This is a profitability ratio that examines the company’s operating performance at a basic level. What is an acceptable profit margin will depend on the industry, the other players in the market and the company’s objectives.
Example:
| Year ended | Year Ended | |
| Mar 31, 2015 | 31-Mar-14 | |
| Operating Profit Margin: | 17.04% | 8.50% |
| (Profit before tax and Other Income ÷ Total Revenue) | ||
| Profit before tax and Other Income | 40,283 | 19,462 |
| Total Revenue | 236,355 |
228,936 |
The operating profit margin for Y/E March 2015 is higher than 2014 due to significantly higher earnings and higher total revenue. This implies that the expenses for the current year are significantly lower than in 2014.
2. Net Profit Margin:
This ratio seeks to measures the profitability of the company’s operations for every dollar’s worth of revenue and/or income it earns.
Example:
| Year ended | Year Ended | |
| 31-Mar-15 | 31-Mar-14 | |
| Net Profit Margin | 17.32% | 9.71% |
| (Profit after tax ÷ Total Income) | ||
| Profit after tax | 45,877 | 22,895 |
| Total Income (Revenue + Other Income) | 264,888 | 235,807 |
The net profit margin for 2015 increased over that of 2014 resulting from a reduction in overall expenditure in 2015. This margin is well above industry performance and in line with the company’s expectations based on promotion and expansion efforts put in place in 2014
- Return on Assets:
This ratio seeks identify how effectively the company in utilising its total assets in order to generate revenue, and therefore profit for the business.
Example:
| Year ended | Year Ended | |
| 31-Mar-15 | 31-Mar-14 | |
| Return on Assets | 5.44% | 0.31% |
| (Profit after tax ÷ Total Assets) | ||
| Profit after tax | 45,877 | 2,290 |
| Total Assets | 842,621 | 728,214 |
The Return on Assets for 2015 increased significantly over prior year as a result of reduction in operational expenditure. Again the activities undertaken in 2014 may be bearing fruit, possibly the closure of a loss making unit or the acquisition of a profit making one.
- Return on Equity:
Here we are looking at the interest of the shareholders what they can expect to gain from their investment in the business. Shareholders usually benchmark their expected return based on say, industry practices or maybe government bond rates.
Example:
| Year ended | Year Ended | |
| 31-Mar-15 | 31-Mar-14 | |
| Return on Equity | 8.31% | 0.42% |
| (Profit after tax ÷ Total Shareholders’ Equity) | ||
| Profit after tax | 45,877 | 2,290 |
| Total Shareholders’ Equity | 552,024 | 547,436 |
The Return on Equity for 2015 increased dramatically over that of 2014 due mainly to significant increase in profitability. The performance may still be well below industry results and the company will need to consider what, if any, actions need to be taken.
- Current Ratio:
This ratio measure how many times total current assets will cover (or take care of) total current liabilities. Industry best practice suggests that a minimum ratio of 2 times is generally acceptable.
Example:
| Year ended | Year Ended | |
| 31-Mar-15 | 31-Mar-14 | |
| Current Ratio | 2.12 times | 2.85 times |
| (Current Assets ÷ Current liabilities) | ||
| Current Assets | 581,761 | 469,073 |
| Current Liabilities | 274,148 | 164,328 |
| Working Capital (Current Assets less Current Liabilities ) | 307,613 | 304,744 |
The Current Ratio is higher than the generally accepted minimum ratio of 2 times, which implies that the company is more than capable of meeting its short term/current liabilities from its current assets.
- Quick (Acid Test) Ratio:
This ratio is derived from the Current Ratio in that, only liquid (can be easily converted to cash) or near liquid current assets), and “true” current liabilities (excluding things like deferred income) are only considered. A minimum ratio of 1 time is generally accepted by most companies.
Example:
| Year ended | Year Ended | |
| 31-Mar-15 | 31-Mar-14 | |
| Quick (Acid Test) Ratio | 11.58 times | 9.30 times |
| (Liquid Assets ÷ “True” Current liabilities) | ||
| Liquid Assets (Cash & short-term investments) | 513,369 | 421,881 |
| “True” Current Liabilities | 44,351 | 40,747 |
The Quick (Acid Test) Ratio more than exceeds the minimum acceptable ratio of 1 time (numerous times over),
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