KENT INVEST by liaoqinmei


          Introduction to Financial Ratio’s

• This presentation has been put together using Board’s
  Knowledge, Financial Accounting Lectures and Textbook

• The presentation has mainly been designed to provide those
  Analysts without any Accounting Knowledge about the key
  Accounting and Financial Ratio’s analysis needed to
  successfully evaluate a Company’s Financial Position.

• However should be used by all Analysts as it aims to highlight
  the key Financial Ratio’s that are required for Investing, Capital
  Markets and in specific for Kent Invest.

      Aims of the Presentation
• A brief introduction behind Annual Reports

• Introduce why we use Financial Ratio’s

• Explain the fundamentals behind a Companies Income
  Statement, Balance Sheet and Cash Flow Statement

• Introduce all the Financial Ratio’s but emphasize on those that
  are relevant to Investing, Capital Markets and Kent Invest

• Explain the problems behind using Financial Ratio’s

    Introduction To Annual Reports
•   Public Limited Companies, are companies which are floated on the stock market,
    this means that they are permitted to offer its shares to the public, so anyone can
    buy them!

•   Under the Companies Act 1985, all PLC’s are legally responsible to produce
    Annual Reports of the company.

•   Within PLC’s there is a business entity that exists between the Directors and the
    Shareholders. Directors are elected by the shareholders to run the company on a
    day to day basis. While shareholders simply own the company and do hence not
    have an active role in the day to day operations of the company.

•   It is the responsibility of the Directors to produce Annual Reports of the company,
    so that the shareholders can use the statements to make investment decisions.
    This is all due to the business entity that exists, as explained above.

Who Uses These Annual Reports?
 The main users of Annual Reports:-

 •   Shareholders
 •   Investors and Potential Investors (i.e. The stock market)
 •   Competitors
 •   Banks
 •   Tax Authorities

What Is Included In These Annual Reports?
  The key information included in these annual reports:-

  •   Information about the company and what they actually do

  •   The Industry that the company operates in

  •   Principle risks and uncertainties that the Company and Industry face

  •   The Financial Statements
     Income Statement (Profit and Loss Account)
     Balance Sheet
     Cash Flow Statement

  •   Share prices

  •   Future predications and forecasts

Kent Invest and Annual Reports
• Our main focus from Kent Invest will be to look at the Financial
  Statements within the Annual Reports. However there are many
  crucial points which are not included in the Financial Statements
  which are very important and need to be taken into consideration

These are:-

•   A brief introduction about the Company and what they actually do
•   Detailed information about the Industry that the company operates in, which
    includes the principal risks and uncertainties regarding of Industry
•   The achievements and strengths of the Company
•   But more crucially the principal risks and uncertainties that surround the company

• The above information with the Financial Statements will be the
  main driving force behind our investment decisions!

 The Creditability Of Annual Reports
• Directors of Companies are also responsible for producing Annual
  Reports in correspondence to Accounting Standards

• Accounting Standards are specific Accounting Policies and standards
  that must be followed by the directors to ensure that the Annual
  Reports show a true and fair view of the company

• It is a legal requirement that the Annual Reports of PLC’s are Audited

• An Auditor is an independent accountant who is appointed by the
  shareholders of the Company to verify that the Annual Reports have
  been properly prepared in accordance to Accounting Standards and
  that they show a true and fair view of the company

The Limitations Of Annual Reports
 • They are based on past data. When investment decisions are
   made, parties are investing in the future of the company and not
   the past. However past performance is the best indication that
   we have for the future.

 • The directors make judgements and estimates which may not
   be accurate

 • Within the Financial Statements the information is regarding
   aggregated totals that can make analysis of the Company

Introduction To Financial Ratio’s
• Financial Ratio analysis is our main technique of analysing and
  interpreting the Financial Statements of a company, which are
  found in the Annual Reports

• Financial Statements are our main method of measuring a
  Companies performance.

• Financial ratios measure the relationship between two variables

• We can only draw meaningful conclusions about a Company by
  using a range of ratios that cover different aspects of the

    Calculating Financial Ratio’s
• We calculate Financial Ratios by using the Companies Financial

So what is included in these Financial Statements?

•   Income Statement (Profit and Loss Account)
•   Balance Sheet
•   Cash Flow Statement

What Is An Income Statement?

• An income statement is a measure of Financial performance
  within a time period.

The key information included in an Income Statement:-

•   Turnover
•   Overheads
•   Gross Profit
•   Net Profit
•   Retained Profits
•   Dividend Payments

      What Is A Balance Sheet?
• The Balance Sheet is a measure of a Company’s Financial
  Position at a Particular moment in time.

The key information included in an Income Statement:-

•   Non-Current Assets
•   Current Assets
•   Stock/Inventories
•   Cash
•   Current Liabilities
•   Non-Current Liabilities
•   Debt
•   Equity

Problems With The Balance Sheet

 • Balance Sheets are a snapshot are a snapshot of a Company at
   a particular point in time and many not be typical of the whole
   year because of seasonal variations.

What Is A Cash Flow Statement?
 • The Cash Flow statement is concerned with the flow of cash in
   and cash out of a Company within a time period. The Cash Flow
   statement shows how changes in the Income Statement and
   Balance Sheet affect Cash.

 The key information included in an Income Statement:-

 •   Operating activities
 •   Investing activities
 •   Finance activities

 • Cash is the one of the most important assets of a Company!

A Key Point About Financial Ratio’s
• Not every Financial Ratio may be relevant to Companies within
  a particular industry.

• You will notice key difference between Financial Statements of
  Companies which are in different industries.

• Financial Ratio’s can only be used to compare Company’s
  within the same industry.

• However very often you may be better off to compare a
  Company’s Financial Ratio’s with the industry averages of the
  industry that the company is in.

Kent Invest And Financial Ratio’s
 • Factset will already have all of the key Financial Ratio’s
   calculated for you.

 However its is important that you:-

 •   Can understand where these ratios have come from
 •   How they have been calculated
 •   What they represent and the interpretation behind them

Advantages Of Using Financial Ratio’s
  • They enable us to cover all aspects of a Companies
    performance in terms of performance, position, financial
    adaptability and shareholder returns

  • It allows us to spot trends when making comparisons between
   It can help to identify whether the business is improving or getting worse

  • They provide a basis for comparison between Companies within
    the same industry and to the industry average

Problems Of Using Financial Ratio’s
 • Comparison between different Companies within the same
   industry can be difficult due to the differences in the adoption
   and application of accounting policies

 • Financial Ratio’s ignore absolute values

 • Financial Statements are produced at one point in time which
   will therefore impact the value of Financial Ratio’s. This is
   because points in time may not be typical due to seasonal

 • Window dressing
  When numbers are deliberately manipulated to improve their appearance

     Types of Financial Ratio’s
• Profitability

• Liquidity

• Gearing

• Investor

• Cash Flow

                Profitability Ratio’s
• Profit is our main measure of financial performance as it is important
  to the Company because it finances dividends and retained profits.

• Retained profits are profits that the business sets aside for future re-
  investment. However retained profits can be used to pay dividends if
  the Company has suffered low profitability and is struggling to finance
  dividends from current profits.

                             Profitability Ratio’s
1)      Gross Profit Margin (%)

    Gross profit            x 100       BOTH FOUND IN THE INCOME STATEMENT

•     Gross Profit = (Sales Revenue – Cost of Sales)
•     Cost of Sales are not expenses!

Cost of Sales equals:-

•     Opening Stock
•     Add Purchases (of inventories)
•     Add Carriage In (the cost of transportation of the inventories)
•     Add Returns In (the cost of inventories that have been returned by customers)
•     Less Returns Out (the cost of inventories that we have gave back to our suppliers)

•     The Gross Profit Margin measures the Gross Profit in pence on each £1 of revenue.
•     The Gross Profit Margin is only relevant to Company’s who trade and is not relevant
      to service based Companies!

                   Profitability Ratio’s
2) Operating Profit Margin (%)

Operating profit x 100    BOTH FOUND IN THE INCOME STATEMENT

•   Operating Profit = (Revenue – Total Expenses)
•   Revenue does not include Interest Received
•   Total Expenses do not include Interest Paid and Corporation Tax

•   Operating Profit Margin measures the Operating Profit in pence on each
    £1 of revenue

                      Profitability Ratio’s
3) Return On Capital Employed (%)

Operating profit       x 100      BOTH FOUND IN THE BALANCE SHEET
Total Capital Employed

•   Total Capital Employed = (Long-Term Debt + Shareholders Equity)
•   Long-Term Debt can be found in the Balance Sheet under Borrowings
•   Shareholders equity is equal to the balancing figures in the Balance Sheet

•   Total Capital Employed can be interpreted as the long-term cost of financing the
    investment of the Company
•   Return On Capital Employed measures the Operating Profit in pence from each £1 of
    long-term finance invested in the business
•   This measure is equivalent to your rate of return of the investment

                   Profitability Ratio’s
4) Return On Equity (%)

Profit After Tax    x 100
Shareholders Equity

• Profit After Tax = (Operating Profit – Interest Paid – Corporation Tax)
• Shareholders Equity is once again equal to the balancing figures in the
  Balance Sheet

• Return On Equity is used by the Shareholders of the Company
• Return On Equity measures the profit that the business is able to used to
  pay dividends in pence on each £1 of Shareholders Equity
• Return On Equity is the maximum amount of dividend that a Shareholder is
  expected to receive
                    Liquidity Ratio’s
• Liquidity is the ability of a Company being able to pay its debts as and
  when they fall due, which is crucial to the short term survival of the

• A company needs sufficient liquidity to finance its day to day operations

• Is too much liquidity a bad thing?
 YES!
 It means that the Company has too much Financial resources in non-
  profit generating activities, so the Finance could be better off
  somewhere else generating profit for the Company
 To determine whether the company has a suitable amount of liquidity, it
  will require comparison against the industry average, as different
  industries will require different levels of liquidity!

                     Liquidity Ratio’s
1. Working capital or current ratio

    Current assets
    Current liabilities
This measures the resources that are available (or will shortly be available) to pay
each £1 of short-term debt.
A value of between 1 and 2 is generally considered desirable,
But it very much depends on the industry e.g. supermarkets
operate at very low levels.

                  Liquidity Ratio’s
    2. Liquid or acid test ratio

 Current assets excluding inventory
 Current liabilities
This recognises that it may take a long time to turn inventory into cash.
     It is a better measure of the ability to pay bills in a hurry.
A value of 1:1 is generally considered desirable, but as

                     Liquidity Ratio’s
  3. Inventory (stock) days

       Inventory    x 365
        Cost of sales
This measures how long it takes to sell the inventories held, in days.
The inventory management principle of just-in-time suggests that this
 should be minimised. However, this needs to be balanced against
 offering choice to customers.

                             Gearing Ratios
•   Gearing is concerned with the long-term liquidity of the Company

•   Gearing looks at how a Company is financed in the long-term

There are two sources of long-term finance for a company:-

•   Equity
   This is the shareholders finance. This is lower risk because the Company can choose on whether they
    want to pay a dividends and the level of them

•   Debt
   This is from lenders such as banks. This is higher risk because the Company must pay its repayments
    and make interest payments

•   A highly geared company is one that relies principally on debt for its finance.

•   A lowly geared company is one that relies principally on equity for its finance.

               Gearing Ratio’s
1. Debt to equity

   Debt or Borrowings            x 100
   Equity (capital and reserves)

This measures the level of debt in relation to the owners’
Less than 100% is considered low geared.

                    Investor Ratio’s
• Investor ratios are important because the shareholders are the owners
  of the Company and these will determine the rate of return on their

• Investors will be aiming to maximise their returns on their investments

• Obviously there is a opportunity cost involved for investors

                     Investor Ratio’s
1. Earnings per share

     Profit after tax  x 100 (to express in pence)
     Total number of equity shares
This is expressed in pence and the figure will be given at the end of the income
It represents the maximum dividend that could have been paid out of current
year’s profit.

             Investor Ratio’s
2. Dividend per share

   Total dividend x 100 (to express in pence)
   Total number of equity shares

The dividend is expressed in pence. The figure will
be found in the Directors’ Report.

                  Investor Ratio’s
3. Dividend yield

    Total dividend (in pence) x 100
    Current market price (in pence)

This measures the current level of return on the investment
which can then be compared with the return available on
alternative investments such as bank deposits, government
bonds or other equity investments.

                     Investor Ratio’s
4. PE Ratio (Price/earnings ratio)

    Current market price (in pence)

•   It measures the market price as a multiple of the EPS
•   It is a general measure of whether or not an investment represents value for

Rule of thumb:
P/E 10 Ratio – Slow-growing company being in a slow-growing industry, like
the automobile industry

P/E 30 Ratio – Type of valuation usually placed by only the fastest-growing
companies by investors in a company’s early stages of growth

               Investor Ratio’s
5. PE to Growth Ratio (PEG ratio)

  = Price/Earnings Ratio
    Annual EPS Growth

• Indicator of stock’s potential value
• Favoured by many over PE ratio because it also accounts for
• Variations of using PEG ratio, 1 year, 5 year, be sure you
  understand the exact definition of the source you are using

               Investor Ratio’s
6. Price to cash flow

   Current market price (in pence)
   Cash flow per share

Similar to the PE Ratio but based on cash flow rather than
profit. Its value is that cash flow may be more reliable
than profit.

           Cash Flow Ratio’s
1. Cash flow per share
   Cash flow from operating activities
   Total number of equity shares

   If the net cash flow from operating activities figure is
   used (after interest and tax) in the CFS we can make a
   more direct comparison with EPS.
   Show value in pence.


To top