Ratio report
The ratio report can be output to PDF or Word. There following ratios are produced on the Ratio Report:
- Current ratio
- Quick ratio (the acid test)
- Debtors to working capital ratio
- Inventory to working capital ratio
- Non-current liabilities to working capital ratio
- Sales to working capital ratio
- Days trade receivables
- Days inventories
- Days trade payables
- Interest cover
- Profit margin
- Return on investment
- Net property, plant and equipment to total equity
- Asset turnover
- Return on assets
- Debt ratio
- Owner's equity ratio
- Gearing ratio
- Debt to equity ratio
- Financial leverage index
The ratio report is relatively subjective, and it may be useful for some or all of the ratios.
There are several ways to arbitrarily calculate ratios and one method for each ratio has been chosen. For instance, for days inventories, sales is used as denominator and this provides is an insight into how many days inventory is held before it is sold. We advise that you operate on a take them or leave them basis for each ratio, with some ratios being more useful for trends than accurate measurements.
The following shows some example ratios and explanatory notes.
Current ratio
- Total current assets ÷ Total current liabilities
- 92,188 ÷ 54,850 = 1.68 times
The target for this ratio is greater than 1.00, which means the company can pay its immediate bills with its short-term assets (cash, receivables, inventories, etc).
A ratio of 1.68, achieved in the example, indicates a healthy buffer of current assets over current liabilities.
Quick ratio (the acid test)
- (Total current assets - Inventories) ÷ (Total current liabilities - Bank overdraft)
- (92,188 - 59,525) ÷ (54,850 - 2,651) = 0.63 times
For companies with inventory, this provides more meaningful information as it takes inventory out of the equation.
Inventory is eliminated in the quick ratio equation on the basis that it is not liquid and therefore may not instantly be converted to cash. As with the current ratio, the objective is to have a quick ratio greater than 1.00.
In the example provided, inventory accounts for more than half of the current assets and once taken out, there are only 63 cents of current assets for every dollar of current liabilities. This is a decline on last year and flags potential short-term cash flow difficulties.
The analysis shows that inventories increased 65% over the prior period and this increase had a detrimental effect on cash. This could result in inventories being sold under a ‘fire sale’ condition and if this occurs it has the potential to adversely impact future profits.
Days trade receivables
- (Trade receivables x 365) ÷ Sales
- (14,344 x 365) ÷ 462,781 = 11 days
As the proportion of cash sales to credit sales increases, the number of days will decrease. If all sales are credit sales, then the number of days should be close to the average credit terms. If it is higher than that specified in the average credit terms, it may indicate slow collection rates and point to a higher risk of bad debts.
In our example we know that 60% of sales are cash sales. By applying this equation (14,344 x 365) ÷ (462,781 x 40%) we can establish the collection rate for credit sales is 28 days. This is in line with the average 30 days credit terms stated in the company’s accounting policy.
Days inventories
- (Inventories x 365) ÷ Sales
- (59,525 x 365) ÷ 462,781 = 47 days
This shows how many days inventory is held before it is sold. It should be extremely low for perishable items, mid-range for fast moving consumer goods and higher for higher value items.
In our example, inventory turnover is 47 days, which is up from 30 days in the prior year. This is due to inventory increasing 65% (as mentioned earlier) and sales only increasing 7%.
As this is a fast moving consumer goods company and inventory becomes obsolete quickly, 47 days is a concern.
In addition to the risk of obsolescence, there are finance, storage and logistical costs involved. Unless there is a significant uplift in sales, inventory, and by extension the number of days inventories is held needs to be reduced to levels in line with the prior year.
Days trade payables
- (Trade payables x 365) ÷ Sales
- (18,070 x 365) ÷ 462,781 = 14 days
This ratio indicates how many days it would take for payables to be paid from sales. It is a hypothetical measure of what could be done, rather than an actual measure of what is done.
The target figure should be in line with the suppliers credit terms, which typically range from 14 to 90 days.
A ratio of 14 days, as in the example, indicates the company is in a strong position to pay its bills in a timely manner. It is however worth noting that this ratio has increased from the prior year.
Interest cover
- (Profit before income tax - Interest revenue + Finance costs) ÷ Finance costs
- (45,415 - 1,087 + 2,239) ÷ 2,239 = 21 times
This indicates how many times profit will cover the finance costs and, as such, how comfortable the company is in meeting its finance obligations (noting that there are also principal repayments to consider).
It is also an indicator of the company’s ability to borrow and a minimum level of cover is considered to be 3 times.
In the example provided, the ratio is a very healthy 21 times and profit would have to reduce drastically for there to be an issue. It also indicates that the company has the capacity to borrow more (when or if required).
Profit margin
- Profit before income tax ÷ Sales
- 45,415 ÷ 462,781 = 10%
Profit margin is the ratio that shows the percentage of sales that ends up as profit.
The target or goal for this ratio will vary from industry to industry. The 10% achieved by the example company is healthy and compares favourably with its peers.
Return on investment
- Profit after income tax ÷ Total equity
- 32,550 ÷ 225,931 = 14%
This indicates the return on equity, so not just the invested capital but also the reserves and retained profits. This would have to be compared to the share price (and resulting market capitalisation, if publicly listed) and dividends paid (per the company’s dividend policy).
The expectation is that returns should be higher where the risks, real or perceived, are higher.
In the example, a 14% return indicates a healthy return on investment. Compared to the example company’s share price of 2.85, market capitalisation of 418,693 and dividends paid of 0.20 per share, it should be noted that the return is diminished to 8% of market value. However, this remains a good result relative to its peer group and the risks associated with the company.
Debt ratio
- Total liabilities ÷ Total assets
- 91,636 ÷ 317,567 = 29%
The debt ratio clarifies the percentage of assets that are funded by liabilities.
Ideally this would not exceed 100% and is generally less than 60%, although this will vary depending on the industry in which a company operates.
At 29% our example company is not highly geared and this supports the earlier observation that the company has the capacity to borrow more (when or if required).
Debt to equity ratio
- Total liabilities ÷ Total equity
- 91,636 ÷ 225,931 = 41%
The debt to equity ratio is a measure of the ratio of liabilities to equity and therefore an indicator of risk.
If the debt to equity ratio is greater than 100% it indicates that creditors and lenders have a greater risk than shareholders.
Acceptable debt to equity ratios will vary according to industry, however 150% is usually regarded as the upper limit, regardless of industry.
The example company’s ratio of 41% is good and confirms earlier assessments related to its low gearing and favourable borrowing capacity.