INTERPRETATION OF FINANCIAL STATEMENTS (ACCOUNTING RATIOS) - PART 2

Recent questions

• How are efficiency ratios calculated?

  Efficiency ratios focus on activity and working capital items like debt collection and inventory turnover periods. The inventory turnover period formula involves dividing the average inventory by the cost of sales and multiplying it by the relevant period, which can be in days, weeks, or months. The debt collection period formula is calculated by dividing trade receivables by credit sales and multiplying it by the relevant period. For the creditors payment period, divide trade payables by credit purchases or cost of sales and multiply it by the relevant period. These ratios help assess financial health and liquidity by analyzing how efficiently a company manages its assets and liabilities.

• What is the significance of gearing and investor ratios?

  Gearing and investor ratios focus on debt and capital structure in a company. Capital structure refers to the mix of debt and equity, with the debt to equity ratio measuring the relationship between the two. High gearing indicates more debt than equity, while low gearing is the opposite. The fixed interest cover ratio assesses the ability to pay fixed interest from profits, while the fixed dividend cover ratio evaluates the ability to pay fixed dividends from profits. Shareholder investment ratios measure returns to shareholders for worth maximization, providing insights into how well a company is utilizing its resources to generate profits and returns for investors.

• How is earnings per share calculated?

  Earnings per share is a key metric in financial analysis, calculated by dividing earnings by the total number of ordinary shares in the company. Earnings refer to net profit after tax minus preference dividends, and to determine earnings per share, divide net profit after tax minus preference dividend by the total number of ordinary shares. Comparing earnings per share with the industry average can indicate how well a company is performing relative to competitors, potentially attracting more shareholders and increasing share price. This metric is crucial for investors to assess the profitability and value of a company's shares.

• What is the dividend payout ratio?

  The dividend payout ratio is the proportion of earnings paid to shareholders as dividends, calculated by dividing the total dividend by the total number of shares. This ratio shows the percentage of earnings that a company distributes to its shareholders as dividends, reflecting the company's dividend policy and commitment to returning profits to investors. A higher dividend payout ratio indicates that the company is distributing more of its earnings as dividends, while a lower ratio suggests that the company is retaining more earnings for reinvestment or future growth opportunities.

• How is the price-earnings ratio interpreted?

  The price-earnings ratio (PE ratio) is calculated by dividing the market price per share by the earnings per share, indicating the number of years it would take for a shareholder to recover their initial investment. A lower PE ratio is generally more favorable for investors, as it suggests that the stock is undervalued or has strong earnings potential. By comparing the PE ratio with competitors, investors can assess how quickly they can recoup their investment in a particular company. Analyzing trends in the PE ratio over time can provide insights into the company's valuation and attractiveness to investors, influencing investment decisions and stock performance.