Using Financial Ratios

A2 Business Studies

Aim: To understand the value and limitations of ratio

analysis

Objectives: Recap on financial accountsDescribe the values and limitations of ratio analysisAnalyse and Evaluate the values and limitations of

ratio analysis

Aims and Objectives

Define a balance sheet Define a tpl/income statement Explain 4 items you may find in each Define a financial objective Write the equation to calculate:

Gearing Liquidity ROCE Net Profit Margin Dividend Yield

Starter

When considering ratio results, the type of business must be considered.

Manufacturers may need high levels of liquidity to enable them to purchase large amounts of stock

Retailers’ figure may be much lower Jewellers have high profit margins, whereas

other industries may have small margins, but sell in vast quantities.

Examiners Tip

In groups brainstorm:

Why firms may use ratio analysis

To what extent is ratio analysis beneficial/valuable for firms to use.

Value/Uses of Ratio Analysis

A

B

C

D

E

1) By using a range of ratios it is possible for an existing shareholder, stakeholder or investor to make direct comparisons with other firms.

E.g. Comparing current ratios of Apple and Microsoft.

Values/Uses of Ratio Analysis

2) Liquidity ratios are of particular interest to the management, their suppliers and their creditors to look at the businesses ability to pay its debts.

Values/Uses of Ratio Analysis

3) Efficiency ratios provide specific evidence as to how well the management is controlling the business. Of interest to shareholders, managers, employees and competitors.

Values/Uses of Ratio Analysis

4) Profitability measures the success of the business.

5) Gearing measures the extent to which the business is running on borrowed money.

6) Shareholder ratios provide vital information to shareholders or investors regarding the rate of return.

Values/Uses of Ratio Analysis

Brainstorm in groups the limitations of ratio analysis

Limitations of Ratio Analysis

A

B

C

D

E

1. Ratios are only really averages2. Ratios are taken over the whole business

which may be concealing parts of the business which are performing badly

3. On its own a ratio tells us nothing. It must be compared with historical data or other firms.

4. Businesses can distort the figures depending on which accounting methods they have used

5. Inflation needs to be taken into account. An increase in sales may hide the fact that no improvements have been made.

Limitations of Ratio Analysis

6. The financial statements used only show current performance and do not predict future trends.

7. Ratios need to be looked at in a context of a business, and an industry or they mean nothing.

Limitations of Ratio Analysis

To what extent is this exercise and analysis valuable to the business (18 Marks)

ContentApplicationAnalysisEvaluation

Case Study