The Main Financial Accounting Ratios

·         Return on Capital Employed (Primary Ratio, ROCE)

Trading profit as a percentage of capital employed

Trading profit must be before deduction of any return to providers of long-term funds, and is usually taken before any exceptional items – thus is profit before interest and tax. Capital employed is the total long-term funding of the business, calculated as shareholders’ funds (including all reserves) plus all long term loans. Some authorities also include any excess of current liabilities over current assets, as this is, effectively, long term funding.

·         Return on Shareholders’ Funds

Profit available to equity shareholders as a percentage of equity capital

The profit figure is after all deductions, including any preference dividend, but before any equity dividend. Equity capital is ordinary share capital plus all reserves (exclude preference share capital)

·         Gross profit margin

Gross profit as a percentage of sales

This is a key measure of the relationship between input cost and price. It will change only as a result of changes in cost or selling prices. A less used, but allied ratio is “mark-up” which tells the same story but by calculating gross profit as a percentage of cost of sales.

·         Net profit margin

Net profit as a percentage of sales

This is best seen as indicating how much of each £1 of sales (in pence) is left as profit after all expenses are deducted. As a comparative measure over time, it is usual to use trading profit (before interest and tax), although other statement of comprehensive income figures can be used. One approach is to calculate all of the profit and loss figures as a percentage of sales.

·         Current ratio

The number of times current assets covers current liabilities

·         Quick assets ratio (acid test or liquidity ratio)

The number of times current assets less stocks and work-in-progress cover current liabilities

·         Debtors turnover (credit given)

Average debtors divided by credit sales times 365 days

Average debtors is usually taken to be the statement of financial position figure at the end of the year, but it is more accurate to average the debtors over the period during which the sales were earned, if opening statement of financial position figures are available

·         Creditors turnover (credit taken)

Average creditors divided by cost of sales times 365 days

·         Stock turnover

Average stock divided by cost of sales times 365 days

As with debtors and creditors, the average is often assumed to be the end of period statement of financial position figure, but a more accurate calculation will result if opening and closing stock for the period are averaged

·         Asset turnover

Sales divided by non-current assets (or total assets less current liabilities)

This seeks to measure how effectively assets are being used to generate sales. Used with care, it’s a useful measure in a capital intensive organisation, but it is easily distorted by the effects of changes in assets and depreciation. Sales or profit per employee might be more useful in a labour intensive organisation.

·         Gearing

Long term borrowing as a percentage of capital employed

This is sometimes alternatively calculated as long term borrowing as a percentage of shareholders’ funds. A further variant is to include excess current liabilities over current assets or even all current liabilities, as part of borrowing. A more accurate assessment of the risks of gearing can be gained from the interest cover ratio.

·         Interest cover

The number of times profit before interest covers the interest charge

·         Earnings per share

Profit available to equity shareholders divided by number of issued shares

·         Price/earnings ratio

Share price divided by earnings per share

To be most useful, this should be calculated using the average share price during the year in which the earnings were made, but this is rarely done. Most commonly the last reported earnings are compared with current share price, thus turning the ratio into a measure of the stock market’s expectations about the company

·         Horizontal or trend analysis

If two of more years’ figures are available, the percentage change of key indicators (such as sales, various costs, working capital, gearing, etc.) can be calculated over time.