Ratio Analysis - Class 12, Accountancy Video Lecture

hi there in this short video we're going
to introduce the important concept of
ratio analysis a ratio analysis is a
common part of your studies of business
performance it involves a comparison of
data typically financial data and the
aim of ratio analysis is to use that
comparison and interpretation of
financial data to gain insights into how
a business is performing ratio analysis
is very widely used in business because
it helps answer some key questions for
example why is one business more
profitable than another or why is one
business less profitable than another
what kind of returns are being earned by
the shareholders from their investment
in the business or by a business as it
invests in its projects how solvent is a
business is it able to pay its debts
when they become due how well does it
manage its assets particular it's
working capital such as inventories
debtors and creditors ratio analysis
helps answer all of these questions or
but it doesn't necessarily lead to the
solutions to those those questions ratio
analysis is essentially built around
financial information from the financial
records of the business and the two main
sources of information that you'll
typically use as you calculate ratios
are the income statement which is a
historical record of the sales the
income and the costs of a business over
time and also the balance sheet which
you'll remember is a snapshot of the
assets and the liabilities of a business
at a particular point in time so from
the income statement will draw out data
such as revenues or income and sales the
cost of those sales which enables us to
calculate and look at gross profit we
look at the operating profit and the net
profit or profit for the year when we're
looking at profitability ratios from the
balance sheet lots of useful information
in particular we often look at elements
within what winners will win as working
capital so current assets such as
inventories trade debtors
current liabilities which of course
includes amounts owed to suppliers we
look at the level of inventories we look
specifically when we're looking at
efficiency of asset management at those
trade receivables and payables but also
when we're looking at the financial
structure of business we look at the
bottom part of a balance sheet we're
looking at the capital the reserves and
the amounts that are owed in the long
term the long term liabilities of a
business what we've done is we produce
separate revision videos that show you
how to calculate each of the ratios each
of which draws on information from the
income statement and the balance sheet
now terms of ratio analysis the key
process involved in this is firstly to
gather the data of course most of that
will be from the financial accounts of a
business what you then do is you
calculate the ratios having calculated
the ratios importantly what you then
need to do is to analyze and interpret
the results what's the ratio saying and
finally and perhaps most importantly
take some action based on it no point
calculating a ratio unless in particular
if it gives you an insight into business
performance
if you unless you do something about it
in terms of ratios there are quite a few
of them out there we've grouped them
into three main groups profitability
ratios this is looking at the returns or
profits earned by the business both in
terms of a proportion or percentage of
revenues so gross profit margin is gross
profit divided by revenues are pressing
profit margin operating profit divided
by revenues so that's a relative
profitability based on revenues but also
in terms of the return that's earned on
the capital employed in a business
perhaps the most commonly used ratio
there is return on capital employed so
profitability ratio is all about how a
business earns returns liquidity ratios
are all about whether the business is
able to pay its way can it pay its debts
and the two key ones there are the
current ratio and the asset test ratio
which use information from the balance
sheet and thirdly well known as
financial efficiency ratios here we're
looking at the effectiveness of the way
in which your business manages its
finances
so how long does it allow customers to
take before they pay their bills
receivables days how long does it take
before it pays suppliers
payables days how quickly does it
turnover the amount of inventory it
holds in the business and also the
gearing ratio which looks at the the
relative proportion of debt in the
business as a proportion of the overall
capital in the business there is one
more group of ratios known as
shareholder ratios which are all
concerned with the returns earned by
shareholders we're not going to group
those into into this presentation who
use these ratios well of course there
are many different users of accounts and
therefore they're going to be many
different users of the ratios based on
those accounts lots of user groups are
interested in the profitability of a
business of course shareholders in
particular want to understand what kind
of returns are being earned but of
course if you're a competitor you're
certainly interested in the
profitability ratios of your key
competitors and I guess as an employee
you're interested in what kind of
returns and profits are being earned by
your business governments will be
interested in profit particularly when
it comes to understanding how much tax
should be paid on those profits by
businesses liquidity ratios also have
lots of users interested in them in
particular I would say that lenders and
suppliers are particularly interested in
whether a business is able to pay its
debts and that makes sense isn't it if
you're a supplier offering credit to a
business you want to be pretty satisfied
that the business will be able to pay
your invoices when they become due
similarly a lender like a bank would
look very closely at the liquidity
position of a business to make sure that
the business is able to pay the interest
and the amounts the capital amounts owed
on a bank loan for example when it comes
to financial efficiency it's very
similar actually shareholders definitely
want to make sure that the business is
being run efficiently that the capital
tied up in the business is being
minimized lenders and creditors very
very interested in in how the working
capital of a business is managed and of
course competitors will be interested to
see whether a competing business is able
to manage its assets more effectively
efficiency because that could be a
source of competitive advantage there we
go guys that's just a brief introduction
to ratio analysis highlighting the key
areas of ratios and why they're used
what we'll move on to and have done in
other videos is to look in the details
of how each ratios calculated but also
look at the limitations of ratio
analysis