Text books: 1. Weetman, P. (2019).

Financial and Management Accountin

Harlow: Pearson
2. Atrill, P. and McLaney, E. (2018) Accounting and Finance
11th Ed. Harlow: Pearson

Answer the questions below:

1. Definition of financial ratios

Financial ratios provide a quick and relatively simple means of assessing the financial health of a
business. A ratio simply relates one figure appearing in the financial state- ments to another
figure appearing there (for example, operating profit in relation to sales revenue) or, perhaps, to
some resource of the business (for example, operating profit per employee).

2. How the use of financial (or accounting) ratios can help to assess the financial performance and position of a busi

Ratios can be grouped into categories, with each category relating to a particular aspect of financial performance or positio
following broad categories provide a useful basis for explaining the nature of the financial ratios to be dealt with. There are
them:
■ Profitability. Businesses generally exist with the primary purpose of creating wealth for their owners. Profitability ratios p
indication of the degree of success in achieving this purpose. They normally express the profit made in relation to other key
the financial statements, or to some business resource.
■ Efficiency. Ratios may be used to measure the efficiency with which particular business resources, such as inventories or
employees, have been used. These ratios are also referred to as activity ratios.
■ Liquidity. It is vital to the survival of a business that there are sufficient liquid resources available to meet maturing obliga
(that is, amounts owing that must be paid in the near future). Liquidity ratios examine the relationship between liquid resou
amounts due for payment in the near future.
■ Financial gearing. This category of ratios is concerned with the relationship between the contribution to financing a busin
by the owners and the contribution made by lenders. The relationship is important because it has an important effect on th
risk associated with a business. Gearing ratios help to reveal the extent to which loan finance is employed and the conseque
on the level of risk borne by a business.
■ Investment. Ratios may be used by shareholders, who are not involved with man-aging the business, to assess the return
profits and dividends) from their shares.

3. Identify the major categories of ratios that can be used for analysing financial statements

1. Profitability Ratios – These ratios assess a company’s ability to generate profit relative to its revenue, assets, or equity. Exa
Gross Profit Margin
Net Profit Margin
Return on Assets (ROA)
Return on Equity (ROE)
2. Liquidity Ratios – Liquidity ratios measure a company’s ability to meet short-term obligations, reflecting financial flexibility
ratios include:
Current Ratio
Quick Ratio (also known as the Acid-Test Ratio)
3. Efficiency Ratios – These ratios evaluate how effectively a company utilizes its assets and manages its operations. Common
 1. Profitability Ratios – These ratios assess a company’s ability to generate profit relative to its revenue, assets, or equity. Exa
Gross Profit Margin
Net Profit Margin
Return on Assets (ROA)
Return on Equity (ROE)
2. Liquidity Ratios – Liquidity ratios measure a company’s ability to meet short-term obligations, reflecting financial flexibility
ratios include:
Current Ratio
Quick Ratio (also known as the Acid-Test Ratio)
3. Efficiency Ratios – These ratios evaluate how effectively a company utilizes its assets and manages its operations. Common
Inventory Turnover
Receivables Turnover
Asset Turnover
4. Gearing (Leverage) Ratios – Gearing ratios, also known as leverage ratios, show the extent to which a business is financed b
indicators of financial risk. Examples include:
Debt-to-Equity Ratio
Interest Coverage Ratio
5. Investment Ratios – Investment ratios provide insight into the performance and valuation of a company from an investor’s
include:
Earnings per Share (EPS)
Price-to-Earnings (P/E) Ratio
Dividend Yield

4. The need for comparision

1. Comparison Over Time (Trend Analysis) – By examining financial ratios over multiple periods, analysts can identify trends i
approach reveals whether key metrics are improving, stable, or deteriorating, providing insights into the business's financial
challenges or opportunities.
2. Comparison with Industry Averages – Comparing a company's ratios to industry norms helps assess its competitive positio
weaknesses relative to peers, which can indicate whether a business is leading or lagging within its sector.
3. Comparison with Competitors – Directly comparing ratios with specific competitors provides a closer look at how a compa
market rivals. This is particularly useful for assessing efficiency, profitability, and market position.
4. Comparison Against Benchmarks or Targets – Setting internal benchmarks or targets allows a company to gauge performan
By comparing actual results to these benchmarks, management can assess operational success and areas for improvement.

5. Calculating the ratios (categories and expression of formula)

Example:
PROFITABILITY RATIOS
Ratio Definition
ROCE
Ratio Definition
ROSF

Ratio Definition
Operating profit margin

Ratio Definition
Gross profit margin ratio

Ratio Definition
Average inventories’ turnover period

Ratio Definition
Average settlement period for trade receivables
 nd Management Accounting: An Introduction. Chapter 13

8) Accounting and Finance for Non-Specialists. Chapter 6

ce and position of a business?

cial performance or position. The

to be dealt with. There are five of

owners. Profitability ratios provide an

ade in relation to other key figures in

ces, such as inventories or

ble to meet maturing obligations

onship between liquid resources and

ribution to financing a business made

s an important effect on the level of
employed and the consequent effect

usiness, to assess the returns (such as

enue, assets, or equity. Examples include:

eflecting financial flexibility and cash flow management. Key

ges its operations. Common efficiency ratios are:

enue, assets, or equity. Examples include:

eflecting financial flexibility and cash flow management. Key

ges its operations. Common efficiency ratios are:

hich a business is financed by debt versus equity. These ratios are

ompany from an investor’s perspective. Key investment ratios

nalysts can identify trends in a company’s performance. This

nto the business's financial trajectory and potential future

sess its competitive position. It highlights strengths or

s sector.
closer look at how a company stacks up against its main
ompany to gauge performance relative to its strategic goals.
nd areas for improvement.

Meaning
% This ratio expresses the relationship between the operating profit generate

Example
ROCE = 47
(763 + 834)/2 * 100 = 5.9%
 ROCE = 47
(763 + 834)/2 * 100 = 5.9%

Meaning
The return on ordinary shareholders’ funds ratio compares the amount of p

Example
ROSF = 11
(563 + 534)/2 * 100 = 2.0%

Meaning
The operating profit margin ratio relates the operating profit for the period

Operating profit margin = 47

2,681 * 100 = 1.8%

Meaning
The gross profit margin ratio relates the gross profit of the business to the s

Gross profit margin = 409

2,681 * 100 = 15.3%

Meaning
The average inventories’ turnover period ratio measures the average period

Average inventories turnover period = (300 + 406)/2

2,272 * 365 = 56.7 days
en the operating profit generated during a period and the average long-term capital invested in the business.
s ratio compares the amount of profit for the period available to owners, with their average investment in the business during t

he operating profit for the period to the sales revenue.

oss profit of the business to the sales revenue generated for the same period. Gross profit represents the difference between s

atio measures the average period for which inventories are being held

406)/2
72 * 365 = 56.7 days
in the business.
vestment in the business during that same period.

resents the difference between sales rev- enue and the cost of sales.