Fig. 1. Table of ratios

Ratio	Method of calculation
Overall performance
1. Return on capital employed (%)	Net profit before tax and interest x 100
	Capita! employed
2. Return on owners' equity (%)	Net profit after tax x 100
	Owners' equity
Profitability
	Gross profit x 100
3. (a) Gross profit margin (%)	Sales
(b)Mark-up on cost (%)	Gross profit x 100
	Cost of goods sold
4. Net profit margin (%)	Net profit x 100
	Sales
Productivity	Sales
5. Sales per employee ($)	Number of employees
	Sales
6. Assets turnover (times)	Total assets- Current liabilities
	Cost of goods sold
7. Stock turnover (times)	Average stock
	Sales

8. (a) Debtor turnover (times) Debtors

(b) Debtor calculation period (days) Debtors

Liquidity Average sales per day

9. Current ratio Current assets: Current liabilities

10. Acid test or liquid ratio Current assets - Stock: Current liabilities

Investment

11. Dividend yield (%) Gross dividend per share x 100 Market price per share

Capital structure

12. Gearing ratio (%) Long-term loans x 100 Capital employed

13. Interest cover (times) Profit before interest charge Interest charge

Reading and discussion task 1. Read the text and fill in the following chart.

Key indicators	Ratios used	Interpretation
Liguidity	1)
	2)
Capital structure	1)
	2)
Efficiency	1)
	2)
Profitability	1)
	2)
	3)

Business owners just don't have an adequate understanding of their costs. They can figure the obvious items which they handle every day, but they don't allow enough for their fixed and indirect overhead costs, which aren't recognised fully until they come to check up at the end of the year. Frankly, our membership has too little understanding of all the factors that go into making up a price. As a result, very few of them are earning a fair return.

The primary use of financial ratios is to analyse the monetary conditions of a business. They reflect its health. Operating ratios also serve very useful purposes. One is to enable a manager to allocate, budget, and plan. Successful business management makes use of them to begin each year by designating the percentage of each sales dollar that will go to salaries, rent, travel, general administration, and so forth. With such management by forecast, a business owner can control progress and, if things go wrong, make immediate adjustments. It is a means of forcing profitability.

Secondary, by comparing percentage-to-sales ratios derived by administering costs within a business with those compiled from a cross section typical of the field, the owner-manager can get a good idea if his or her operating costs are imbalanced. Then action can be taken to eliminate the imbalances and improve profitability.

In comparing operating ratios for an individual concern with those of a given line of business, the business owner must realise that this comparison is made against averages.

There are four critical areas of company's business, which can be analysed by applying ratios. These are liquidity, capital structure, activity and efficiency, and profitability.

Measurements of liquidity should answer the question: Can a company pay its short-term debts? There are two ratios commonly used to answer this question. Firstly, the current ratio, which measures the current assets against the current liabilities. In most cases, a healthy company would show a ratio above 1, in other words more currents assets than current liabilities. Another method of measuring liquidity is the so-called quick ratio - this is particularly appropriate in manufacturing industries where stock levels can disguise the company's true

liquidity. The ratio is calculated in the same way as above but the stocks are deducted from the current assets.

The balance sheet will also reveal the gearing of the company - this is an indicator of the company's capital structure and its ability to meet its long-term debts. The ratio expresses the relationship between shareholders' funds and loan capital. Income gearing is also important and shows the ratio between profit and interest paid on borrowings. Relatively high borrowings would indicate vulnerability to an interest rate rise. Highly geared companies generally represent a greater risk for investors.

The balance sheet and the profit and loss account can be used to assess how efficiently a company manages its assets. Basically, sales are compared with investment in various assets. For example, in the retail sector, an important ratio which indicates efficiency is sales divided by stock - the resulting figure should be much higher than in the manufacturing sector where stock tends to show a much slower turnover. Another example of efficiency measurement is to calculate the average collection period on debts. This is found by dividing debtors by the sales per day. This can vary tremendously from industry to industry. In the retail sector it may well be as low as one or two days, whereas in the heavy manufacturing and service sectors it can range from thirty to ninety days.

Finally, profitability ratios show the manager's use of the company's resources. The profit margin figure (profit before tax divided by sales and expressed as a percentage) indicates the operational day-to-day profitability of the business. Return on capital employed can be calculated in a number of ways. One common method is to take profit before taxes and divide by the total assets - this is a good indicator of the use of all the assets of the company. From the shareholder's point of view, the return on owner's equity is an important percentage. If the company does not earn a reasonable return, the share price will fall and thus make it difficult to attract additional capital.

TASK 2. Answer the following questions on the text.

1. What don't business owners understand clearly?

2. Why do business owners earn poor return on investments?

3. What reflects the financial state of a business?

4. How many areas can be analysed by applying ratios?

5. Can ability to pay short-term debts be analysed by ratios?

6. What current ratio is appropriate for a healthy company?

7. Is there any difference between quick and current ratios?

8. What ratio indicates the use of assets in a company?

9. What helps attract additional capital into the company?

10.Is capital structure or efficiency important for future investors?

TASK 3. Say if you agree to the following. Give your reasons.

1. Business owners don't have a fair return because they can't recognise their costs on time.

2. Operating ratios are useless to analyse the financial picture of a business.

3. Management forces productivity of a business with the help of ratios.

4. To eliminate imbalances of a business a manager has to compare administering costs with average costs in a given line of business.

5. Liquidity is a measure of company's short-term debts.

6. Leverage shows the relationship between borrowed and proprietorship's capital of a business.

7. Return on capital is a very important ratio for shareholders.

TASK 4. Say, which of the ratios is likely to be the key indicator for the following groups.

• shareholders

• managers

• customers

• suppliers

• employees

TASK 5 A. Complete the list below. You can use a dictionary.

Noun	Adjective	Adverb
Profitability	profitable	profitably
Efficiency
Health
Appropriacy
Operation
Finance
Productivity
management

B. Group the following adjectives under the headings indicated.

Healthy reasonable disastrous disappointing excellent

satisfactory vulnerable poor adequate weak

marvellous moderate strong tremendous catastrophic

Positive Average Negative

________ ________ ________

________ ________ ________

________ ________ ________

________ ________ ________

________ ________ ________

C. Use these adjectives in the following way.

We can say: The company is in a vulnerable position.

We cannot say: The company had vulnerable results.

Which of the adjectives above cannot be used with the following nouns?

1.________________ results

2. _______________condition/position

D. Combine two adjectives from the box to complete the sentences.

a) high	b) lower	c) relative	d)geared
e)particular	f) short	g) unusual	h)particular
i) long	j) appropriate	k) high	l)dangerous
m)considerable	n) high

Example: This is particularly appropriate in manufacturing industries. Relatively hish borrowing would indicate vulnerability to an interest rate rise.

1. Normally a healthy company has a current ratio above 1. This company has an ____ ______ratio of 2.

2.____ _____companies generally represent a greater risk for investors.

3. Retail companies have ___ _____collection period on debts.

4. Most people would consider a collection period over 90 day aS_____.

5. Manufacturing companies have a__ __stock turnover than retail

companies.