I. INTRODUCCIÓN
1.2 Trabajos previos
1.2.1 Internacional
It would not be possible to list every single ratio capable of calculation. The important point to note is that different groups will be interested in using different ratios to reflect their particular interest in the company. You must also remember that ratios should always be considered as part of a trend, and once calculated they require careful interpretation.
Companies often give information on ratios in their five and ten year summaries, but the full set of accounts is essential to allow a full comparison – they are generally only available for the year of the accounts and the previous years.
There are two fundamental reasons why ratio trends are important:
To identify the trends within the business itself over the last few years – for example, to assess whether the business is doing better or worse, or what remedies or corrective action can be taken
To identify how the business is doing compared to similar businesses in the same operating and market environment.
It is also important to recognise that whilst much can be made of ratios and their interpretation, they are after all calculated at a particular point in time. In the past, organisations have been accused of manipulating their year end accounts to perhaps produce a “healthier” looking picture.
Analysing Company Performance
We will now study the use of ratio analysis by considering a detailed example. It is important to remember that you will generally be asked for an interpretation of the ratios identified,
which means you must comment not only on individual ratios, but also on the composite position disclosed by your analysis, including changes in profit before and after tax and turnover. You must also remember, where possible, to look at a selection of ratios with at least one from each of the four main groups we have discussed.
Example
The summarised accounts of New Ideas plc are as follows:
Balance Sheets as at 30 April
Year 2 Year 1
£000 £000
Fixed assets (net) 6,401 2,519
Current assets
Stock 25,426 20,231
Debtors 21,856 20,264
Balance at bank 2,917 6,094
56,600 49,108
Ordinary shares of 50p 5,000 5,000
Revenue reserves 14,763 12,263
Deferred taxation 5,433 3,267
10% Debenture loans 10,000 10,000
Creditors: Amounts falling due within one year
Trade creditors 18,762 16,431
Taxation 1,642 1,247
Dividends 1,000 900
56,600 49,108
Results for the year ended 30 April Year 2 Year 1
£000 £000
Sales 264,626 220,393
Trading profit 9,380 8,362
Interest payable 1,000 1,000
Taxation 4,380 3,642
Dividend 1,500 1,400
The following additional information is provided.
(a) The ordinary shares are quoted at £1.20.
(b) New Ideas plc requires £16 million for an investment project and is considering one of the following:
(i) The issue to shareholders of £16 million 10% convertible (£1 for 1 share) debentures at par.
(ii) A rights issue at 80p.
(iii) The sale in the market of £16 million 13% debentures at par.
You are required to:
(a) Calculate from the balance sheet and results:
(i) Two ratios particularly significant to creditors.
(ii) Two ratios particularly significant to management.
(iii) Two ratios particularly significant to shareholders.
(b) Comment briefly on the change between Year 1 and Year 2 in the ratios you have calculated.
(c) Calculate the immediate effect of the three schemes on the gearing of the company.
(d) Calculate the effect of the three schemes on the earnings per share, on the assumption that the Year 2 profits from the existing assets will be maintained and that the £16m net investment will produce profits of £3.5m before tax and interest. The rate of tax can be assumed at 50% (this is not the current rate but is used for ease of calculation).
Answer
Year 2 Year 1 (a) (i) Ratios significant to creditors
Current ratio
(ii) Ratios significant to management
Activity ratio
Year 2 8,380 : 264,626 3.17%
Year 1 7,362 : 220,393 3.34%
Profitability ratio
(iii) Ratios significant to shareholders
Return on capital employed
funds
Dividend cover ratio
Dividend
interest debenture
and tax after Profit
Year 2 4,000 : 1,500 2.7 : 1
Year 1 3,720 : 1,400 2.7 : 1
Note that after-tax profit is used as this is preferred by shareholders.
(b) Comments on ratios
In spite of an increase in sales of 20% and an increase in pre-tax profits of 13.8%, the ratios mentioned show a marginally unfavourable trend between Year 1 and Year 2.
Among the unfavourable trends, the change in the liquidity ratio may cause concern to creditors.
(c) Effect of fund-raising schemes on gearing Gearing is:
reserves) +
capital (share
Equity
shares Preference
+ capital Loan
This is currently:
50.6%.
19,763 10,000
(i) Issue of £16m 10% convertible debentures changes the gearing to:
131.6%
19,76326,000
(ii) By implementing a rights issue of ordinary shares, the gearing is reduced to:
28.0%
35,763 10,000
(iii) By issuing £16m 13% debentures, the gearing is the same as under (i) above.
It is considered that schemes (i) and (iii) represent a dangerously high level of gearing.
(d) Effect of fund-raising schemes on Earnings per Share The current EPS is calculated as follows:
£000 £000
Trading profit 9,380
less: Interest payable 1,000
Taxation 4,380 5,380
Net profit 4,000
Earnings per share 40p 10,0004,000
(i) On issue of £16m 10% convertible debentures:
£000 £000
Net profit as before 4,000
add: Additional profit 3,500
less: Tax @ 50% 1,750 1,750
5,750 less: Debenture interest (10% on £16m) 1,600
Tax @ 50% 800 800
4,950 Earnings per share 49.5p
10,0004,950
(ii) On issue of 20 million ordinary shares (at 80p each = £16m):
£000 £000
Net profit as before 4,000
add: Additional profit 3,500
less: Tax @ 50% 1,750 1,750
Net profit 5,750
Earnings per share 19.2p 30,0005,750 (iii) On issue of £16m 13% debentures:
£000 £000
Net profit as before 4,000
Additional profit (net) 1,750
5,750 less: Debenture interest (13% on £16m) 2,080
Tax @ 50% 1,040 1,040
4,710 Earnings per share 47.1p
10,0004,710
Note that potential problems can also be detected from the company’s accounts by carefully reading the reports that accompany the figures and the use of significant financial ratios. We shall look at this in more detail in later in the course.
Ratios can also be used in inter-firm comparisons. Inter-firm comparisons involve the contrasting of the results of a company with one or more other companies in order to help assess their relative performances.
Problems with the Use of Ratios
The main difficulty with the use of ratios is the question: “Are we really comparing like with like?”.
Even where the comparison is between two companies of roughly equal size and ambition, there will always be an element of doubt that the comparison has true validity because of alternative accounting policies which can be adopted in areas such as depreciation and the use of off-balance sheet items. One of the biggest problems in all forms of comparison is the differences which occur in the structure and culture of businesses, the economic and general
environment making strict comparison extremely difficult. Similarly, when making
comparisons over time the impact of inflation must be considered because of its impact on turnover, earnings, profit and asset values. However, the comparisons are useful in helping to judge stewardship and the return on the investment relative to others available.
If the accounts are different to those of the industry or segment to which they belong, further investigation may be required by the financial manager or analyst.
The Centre for Inter-firm Comparison
Established by the Institute of Management and the British Productivity Council in 1959, the Centre has evolved the pyramid method of selecting ratios. Under this method the principal ratios are listed at the top of the pyramid, starting with return on capital employed which is referred to as the primary ratio. This is taken to be the key indicator of company
performance and profitability. The ratio is then broken down into a number of subordinate ratios as shown in Figures 2.2 and 2.3. (All ratios shown in the pyramid are compiled for the industry as a whole.)
The overall profitability of the operations of the business, and the overall success of its management, depend on the ratio:
employed
Differences between constituent parts of this ratio could arise from:
Differences in the ratio or Differences in the ratio
Sales
Inter-firm variations could arise from Inter-firm variations could arise from
the ratio of: or the ratio of: or the ratio of:
Sales Figure 2.2: Pyramid Diagram of Ratios – Certain Distributive Trades
(as devised by the Centre for Inter-firm Comparison)
Firms can raise their gross profits either by achieving a higher volume of sales of items earning high gross profits, or by adjusting prices within market constraints. The extent to
which either of them affects total gross profit will be indicated by the inter-firm comparison of ratios showing:
(a) The composition of sales made;
(b) The gross profit achieved on different products.
employed
Figure 2.3: Pyramid Diagram of Ratios – Manufacturing Industries (as devised by the Centre for Inter-firm Comparison)
Once the ratios are compiled for the industry as a whole, they will be prepared for the participating firm. The resultant ratios are then compared and any material deviations investigated.
For example, if the primary ratio shows that the rate of return for the company is less than for the industry as a whole, one or more of the subordinate ratios that make it up must be
affected. This type of comparison will indicate those work areas which are “up to standard”
as well as those which are either under, or over, performing. Senior management can then focus its attention on the specific areas which have been identified.
Advantages and Disadvantages of Inter-firm Comparisons
Advantages Disadvantages
Participating firms can see their efficiency in comparison with others.
It is often difficult to obtain uniformity of procedure, methods and definitions.
Correcting action to address weaknesses can be made in good time.
Some companies hide or refuse to release key data required in the process.
By using a specialist, confidential agency, the fear that personal
company data will pass to a competitor is removed.
The nature of a company’s operations may be too diverse for true
comparison.
Major customers’ and suppliers’
accounts can be compared to
measure their future stability and plans made where serious weaknesses are detected.
The process can be time-consuming and requires specialist skills.