Financial Ratio Toolkit Final Dec 2018

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Sheet 1: Cover

FINANCIAL RATIO ANALYSIS

TOOLKIT

Issued December 2018

THE SOUTH AFRICAN INSTITUTE OF CHARTERED ACCOUNTANTS

Copyright in all publications originated by The South African Institute of Chartered Accountants rests in the Institute. Apart from the extent reasonably necessary for the purposes of research, private study, personal or private use, criticism, review or the reporting of current events, as permitted in terms of the Copyright Act (No. 98 of 1978), no portion may be reproduced by any process without written permission.

ISBN 978-0-86983-424-4

Sheet 2: Disclaimer

DISCLAIMER

All publications in this toolkit are commissioned by the South African Institute of Chartered Accountants (SAICA). This toolkit provides limited financial ratios and is not intended to be all encompassing. It is intended to serve as guidance and not as a form or recommendation.

This toolkit has not been approved, sanctioned, or officially promulgated by SAICA, nor is it intended to represent the standard practice.

This toolkit only sets out limited financial statements, for illustrative purposes and are relevant only for purposes of the toolkit. It does not provide a full set of financial statements that are International Financial Reporting Standards (IFRS) or IFRS for Small and Medium Entities (SMEs) compliant.

Each user of this document is personally responsible for the interpretation and use of the contents of the toolkit and assumes all risks in connection of such use.

This toolkit will not be updated to address and/or amend any changes, therefore each user must use the toolkit as information that has been prepared at a particular point in time, and assumes the responsibility to ensure that they obtain the necessary updated information as may be required, from time to time

Every effort has been made to ensure that the information developed for purposes of this toolkit is accurate. Nevertheless, information is given purely as non-authoritative guidance with respect to the subject matter and SAICA will have no responsibility to any person for any claim of any nature whatsoever which may arise out of or related to the interpretation and use of the contents of this toolkit.

Sheet 3: Introduction

Introduction

This financial toolkit aims to assist the user in calculating some general financial ratios pertaining to the user’s smaller and less complex entities. The toolkit is not aimed to include an exhaustive list of ratios, but rather to serve as a starting point by computing and analysing some key ratios that can assist different stakeholders (e.g. management, the board of directors, shareholders, investors, providers of finance) in making decisions relevant to their circumstances. The main sources that were consulted in order to identify key ratios are included in the 'References' tab.

Financial ratios assist in identifying qualitative and quantitative factors (numeric outcomes) which are relevant to understanding and providing different perspectives regarding the information contained in or to be contained in the entity's financial statements.

In short, financial ratios are tools to assess the relative (and potential) strengths or weaknesses of an entity. They assist in measuring operational efficiency, liquidity, stability and profitability.

Some of the advantages in using ratios include:
(1) Ratios provide a standard method of comparison. In some respects ratios serve to 'level the playing field' as they go beyond the numbers in revealing key messages regarding an entity's operational efficiency, liquidity, stability and profitability.
(2) Industry trends can be determined by creating benchmarks against which performance can be measured.
(3) Investors use ratios to evaluate the strengths and weaknesses of individual companies or industries.
(4) Business owners can use ratios and industry trends to motivate business plans to potential investors, customers, suppliers and providers of finance.

It is important not to miss the bigger picture by only relying on ratios, especially with a complex set of information. Financial ratios are based on past performance and can indicate trends, however the present conditions and future amendments should also be taken into account when interpreting ratios and making decisions.

Definitions and formulas of the ratios in this toolkit

Type of ratio
Ratio
Formula
Explanation

Profitability Ratios
Gross Profit % (GP%)
(Sales less Cost of sales) /
Sales
In general the GP % of an entity should remain fairly static. A decrease in percentage could mean:
(1) the entity has have not responded by increasing prices as suppliers costs have increased;
(2) misappropriation of merchandise either by staff or suppliers in delivery; or
(3) unauthorized discounts, misappropriation of cash revenue and free handouts.

Thus the GP % should be tracked so that mitigation strategies can be put in place at the first sign of a decline.

Profit margin %
(Sales or Revenue less Expenses) /
Sales
The profit margin ratio is a percentage that shows an entity's earnings after deducting all expenses.
Profit margins vary by business, thought it could be useful to compare to industry averages.

Return on Assets
Net Income /
Total Assets
This profitability ratio is used to determine how effectively an entity's assets are used to generate profits. The higher this ratio the more efficient an entity is at using its assets to make money.
This is a very useful measure of comparison within an industry. A low ratio compared to industry may mean that the entity's competitors have found a way to operate more efficiently.

Return on Investment (ROI)
(Earnings less Initial Cost of Investment) / Initial Cost of Investment
ROI compares the amount of money an investment brings into an entity to how much is paid for the investment. This ratio shows the entity's investment and the profit received in return based on the investment. Thus a higher ROI, the more income is generated by investments.

Liquidity Ratios
Quick Ratio
(Total Current Assets less Total Current Inventory) /
Total Current Liabilities
The quick ratio measures short-term liquidity. Liquidity is the ability to pay off current liabilities with current assets (excluding inventory).
Important to note that the current assets used in calculating the quick ratio excludes inventory.

Current ratio
Total Current Assets /
Total Current Liabilities
The current ratio is similar to the quick ratio, but measures your ability to pay long-term debts.
So the current ratio looks at how many assets you have compared to liabilities.
Current ratio includes inventory.

Solvency Ratios
Debt-to-equity ratio
Total Liabilities /
Net Equity
The debt-to-equity ratio shows how dependent an entity is on borrowed finances compared to own funding. This ratio compares how much an entity owe to how much they own.

If the debt-to-equity ratio is greater than 1, the entity has more capital from lenders. This could be seen as a risk when applying for a loan.

Interest Coverage
Earnings Before Interest, Taxes(EBIT) /
Interest Expenses
Interest coverage measures an entity's ability to meet interest payment obligations with business income.
Ratios close to 1 indicates that an entity is having difficulty in generating enough cash flow to pay interest on its debt. The ideal ratio is above 1.5.

Activity Ratios
Accounts Receivable turnover
Credit Sales /
Average Accounts receivable
This activity ratio measures how quickly an entity collects its accounts receivable (evaluate issue of credit and the collection thereof).
A high ratio indicates that the entity is efficient in collecting its debt, while lower ratios can lead to accounts unnecessarily tying up working capital.

Days Credit Sales outstanding
365 days /
Accounts receivable turnover
Day sales outstanding indicates how many days an entity's clients (on credit) take to pay.
An entity should aim to collect payment quicker for which they are extending credit for.

Accounts Payable turnover
Purchases /
Average Accounts payable
This activity ratio shows how quickly an entity pays money owed to its suppliers.
A ratio of 5 suggests that the entity used and paid off credit five times during the year, or once every 73 days. This ratio increases when more purchases are made or an entity decreases its accounts payable.
A high ratio indicates that the entity is paying off its creditors quicker, where as a low ratio indicates the opposite.

Inventory turnover ratio
Cost of Goods Sold /
Average Inventory
An inventory turnover ratio reveals how frequently inventory is converted into sales. It shows how much product is sold and how efficiently inventory is managed.
The greater the inventory turnover ratio, the more frequently inventory converts into cash.

Days Inventory outstanding
365 days /
Inventory Turnover ratio
Day Inventory outstanding indicates average number of days the entity holds its inventory before selling it.
An entity should aim to turn over inventory quickly since this indicates the number of days funds are tied up in inventory.

Days Expenses outstanding
365 days /
Accounts payable turnover
Day expenses outstanding indicates how many days an entity take to pay creditors back.
An entity should aim to extend payment as late as possible to ensure they have sufficient cash on hand.

Operational Efficiency
Adequacy of Resources
(Cash plus Marketable Securities plus Accounts Receivable) /
Monthly Expenses
This ratio determines the number of months an entity could operate without further funds received (burn rate).

Sales Growth %
Yearly Analysis: (Current Year Sales less Previous Year Sales) / Previous Year Sales
Monthly Analysis: (Current Month Sales less Previous Months Sales) / Previous Months Sales
Sales growth indicates a percentage increase (decrease) in sales between two time periods.
If overall costs and inflation are increasing, an entity should see a corresponding increase in sales. If not, they may need to adjust pricing policy to keep up with costs.

Revenue Growth %
Yearly Analysis: (Current Year Revenue less Previous Year Revenue) / Previous Year Revenue
Monthly Analysis: (Current Month Revenue less Previous Months Revenue) / Previous Months Revenue
Revenue growth indicates a percentage increase (decrease) in revenue between two time periods.
If overall costs and inflation are increasing, an entity should see a corresponding increase in revenue. If not, they may need to adjust pricing policy to keep up with costs.

Operating Self-Sufficiency ratio
Sales /
Total expenses
Operating self-sufficiency measures the degree to which an organisation’s expenses are covered by its core business and is able to function independent of grant support.
For this calculation, business revenue should exclude any non-operating revenues or contributions and total expenses should include all expenses (operating and non-operating) including social costs.

Operating income Break-even point
Total fixed costs (in Rands) divided Contribution Margin Ratio
(Contribution Margin or Gross Profit divided by Revenue)
The break-even formula helps determine the value of operating income required in order to ensure your entity will break even. This formula can help you set targets and minimums.

Average sales per customer
Sales /
Average number of customers
Many small businesses miss the opportunity for multiple sales by selling associated products because they don't measure and track the average customer sales results. By measuring the average customer sales the entity may become more aware of significantly improving profits every time an associated sale is made (i.e. belts with trousers, drinks with food).
This is a simple way to seamlessly improving the bottom line.

Revenue per Employee
Sales /
Average number of employees
This ratio can be used to compare the entity against others in the same industry. Ideally, the entity want the highest revenue per employee possible as it indicates higher productivity and effective use of resources.
Revenue per employee is affected by an entity's employee turnover rate, and turnover is defined as the percentage of the total workforce that leaves voluntarily each year and must be replaced.

Total Cost per Employee
Total cost /
Average number of employees
This ratio can be used to analyse the total cost per employee.

Bank Overdraft

Cash and Cash equivalents

Cash Sales

Credit Sales

Cost of Sales

Current portion of Long-term Borrowings

Current Tax Payable

Deferred Tax Asset

Deferred Tax Liability

Depreciation & Amortisation

Employee Costs

Goodwill

Impairments

Income Tax Expense

Interest Expense

Intangible Assets

Investments

Investment Income

Investment Property

Inventories

Loans Receivable - Long Term

Loans Receivables - Short Term

Long-term Borrowings

Long-term Provisions

Other Components of Equity

Other Current Assets

Other Current Liabilites

Other Expenses

Other Income

Other Intangible Assets

Other Non-current Assets

Other Non-current Liabilites

Property, Plant and Equipment

Retained Earnings

Revenue

Share capital/Capital Account/Members Contributions

Short-term Borrowings

Short-term Provisions

Trade Payables

Trade Receivables

The words contained in this file might help you see if this file matches what you are looking for:

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					FINANCIAL RATIO ANALYSIS
					TOOLKIT

					Issued December 2018


COPYRIGHT © 2018

THE SOUTH AFRICAN INSTITUTE OF CHARTERED ACCOUNTANTS

Copyright in all publications originated by The South African Institute of Chartered Accountants rests in the Institute. Apart from the extent reasonably necessary for the purposes of research, private study, personal or private use, criticism, review or the reporting of current events, as permitted in terms of the Copyright Act (No. 98 of 1978), no portion may be reproduced by any process without written permission.


ISBN 978-0-86983-424-4

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Introduction
This financial toolkit aims to assist the user in calculating some general financial ratios pertaining to the user’s smaller and less complex entities. The toolkit is not aimed to include an exhaustive list of ratios, but rather to serve as a starting point by computing and analysing some key ratios that can assist different stakeholders (e.g. management, the board of directors, shareholders, investors, providers of finance) in making decisions relevant to their circumstances. The main sources that were consulted in order to identify key ratios are included in the 'References' tab. Financial ratios assist in identifying qualitative and quantitative factors (numeric outcomes) which are relevant to understanding and providing different perspectives regarding the information contained in or to be contained in the entity's financial statements. In short, financial ratios are tools to assess the relative (and potential) strengths or weaknesses of an entity. They assist in measuring operational efficiency, liquidity, stability and profitability. Some of the advantages in using ratios include: (1) Ratios provide a standard method of comparison. In some respects ratios serve to 'level the playing field' as they go beyond the numbers in revealing key messages regarding an entity's operational efficiency, liquidity, stability and profitability. (2) Industry trends can be determined by creating benchmarks against which performance can be measured. (3) Investors use ratios to evaluate the strengths and weaknesses of individual companies or industries. (4) Business owners can use ratios and industry trends to motivate business plans to potential investors, customers, suppliers and providers of finance. It is important not to miss the bigger picture by only relying on ratios, especially with a complex set of information. Financial ratios are based on past performance and can indicate trends, however the present conditions and future amendments should also be taken into account when interpreting ratios and making decisions.

Definitions and formulas of the ratios in this toolkit
Type of ratio	Ratio	Formula	Explanation
Profitability Ratios	Gross Profit % (GP%)	(Sales less Cost of sales) / Sales	In general the GP % of an entity should remain fairly static. A decrease in percentage could mean: (1) the entity has have not responded by increasing prices as suppliers costs have increased; (2) misappropriation of merchandise either by staff or suppliers in delivery; or (3) unauthorized discounts, misappropriation of cash revenue and free handouts. Thus the GP % should be tracked so that mitigation strategies can be put in place at the first sign of a decline.
	Profit margin %	(Sales or Revenue less Expenses) / Sales	The profit margin ratio is a percentage that shows an entity's earnings after deducting all expenses. Profit margins vary by business, thought it could be useful to compare to industry averages.
	Return on Assets	Net Income / Total Assets	This profitability ratio is used to determine how effectively an entity's assets are used to generate profits. The higher this ratio the more efficient an entity is at using its assets to make money. This is a very useful measure of comparison within an industry. A low ratio compared to industry may mean that the entity's competitors have found a way to operate more efficiently.
	Return on Investment (ROI)	(Earnings less Initial Cost of Investment) / Initial Cost of Investment	ROI compares the amount of money an investment brings into an entity to how much is paid for the investment. This ratio shows the entity's investment and the profit received in return based on the investment. Thus a higher ROI, the more income is generated by investments.
Liquidity Ratios	Quick Ratio	(Total Current Assets less Total Current Inventory) / Total Current Liabilities	The quick ratio measures short-term liquidity. Liquidity is the ability to pay off current liabilities with current assets (excluding inventory). Important to note that the current assets used in calculating the quick ratio excludes inventory.
Liquidity Ratios	Current ratio	Total Current Assets / Total Current Liabilities	The current ratio is similar to the quick ratio, but measures your ability to pay long-term debts. So the current ratio looks at how many assets you have compared to liabilities. Current ratio includes inventory.
Solvency Ratios	Debt-to-equity ratio	Total Liabilities / Net Equity	The debt-to-equity ratio shows how dependent an entity is on borrowed finances compared to own funding. This ratio compares how much an entity owe to how much they own. If the debt-to-equity ratio is greater than 1, the entity has more capital from lenders. This could be seen as a risk when applying for a loan.
Solvency Ratios	Interest Coverage	Earnings Before Interest, Taxes(EBIT) / Interest Expenses	Interest coverage measures an entity's ability to meet interest payment obligations with business income. Ratios close to 1 indicates that an entity is having difficulty in generating enough cash flow to pay interest on its debt. The ideal ratio is above 1.5.
Activity Ratios	Accounts Receivable turnover	Credit Sales / Average Accounts receivable	This activity ratio measures how quickly an entity collects its accounts receivable (evaluate issue of credit and the collection thereof). A high ratio indicates that the entity is efficient in collecting its debt, while lower ratios can lead to accounts unnecessarily tying up working capital.
	Days Credit Sales outstanding	365 days / Accounts receivable turnover	Day sales outstanding indicates how many days an entity's clients (on credit) take to pay. An entity should aim to collect payment quicker for which they are extending credit for.
	Accounts Payable turnover	Purchases / Average Accounts payable	This activity ratio shows how quickly an entity pays money owed to its suppliers. A ratio of 5 suggests that the entity used and paid off credit five times during the year, or once every 73 days. This ratio increases when more purchases are made or an entity decreases its accounts payable. A high ratio indicates that the entity is paying off its creditors quicker, where as a low ratio indicates the opposite.
	Inventory turnover ratio	Cost of Goods Sold / Average Inventory	An inventory turnover ratio reveals how frequently inventory is converted into sales. It shows how much product is sold and how efficiently inventory is managed. The greater the inventory turnover ratio, the more frequently inventory converts into cash.
	Days Inventory outstanding	365 days / Inventory Turnover ratio	Day Inventory outstanding indicates average number of days the entity holds its inventory before selling it. An entity should aim to turn over inventory quickly since this indicates the number of days funds are tied up in inventory.
	Days Expenses outstanding	365 days / Accounts payable turnover	Day expenses outstanding indicates how many days an entity take to pay creditors back. An entity should aim to extend payment as late as possible to ensure they have sufficient cash on hand.
Operational Efficiency	Adequacy of Resources	(Cash plus Marketable Securities plus Accounts Receivable) / Monthly Expenses	This ratio determines the number of months an entity could operate without further funds received (burn rate).
	Sales Growth %	Yearly Analysis: (Current Year Sales less Previous Year Sales) / Previous Year Sales Monthly Analysis: (Current Month Sales less Previous Months Sales) / Previous Months Sales	Sales growth indicates a percentage increase (decrease) in sales between two time periods. If overall costs and inflation are increasing, an entity should see a corresponding increase in sales. If not, they may need to adjust pricing policy to keep up with costs.
	Revenue Growth %	Yearly Analysis: (Current Year Revenue less Previous Year Revenue) / Previous Year Revenue Monthly Analysis: (Current Month Revenue less Previous Months Revenue) / Previous Months Revenue	Revenue growth indicates a percentage increase (decrease) in revenue between two time periods. If overall costs and inflation are increasing, an entity should see a corresponding increase in revenue. If not, they may need to adjust pricing policy to keep up with costs.
	Operating Self-Sufficiency ratio	Sales / Total expenses	Operating self-sufficiency measures the degree to which an organisation’s expenses are covered by its core business and is able to function independent of grant support. For this calculation, business revenue should exclude any non-operating revenues or contributions and total expenses should include all expenses (operating and non-operating) including social costs.
	Operating income Break-even point	Total fixed costs (in Rands) divided Contribution Margin Ratio (Contribution Margin or Gross Profit divided by Revenue)	The break-even formula helps determine the value of operating income required in order to ensure your entity will break even. This formula can help you set targets and minimums.
	Average sales per customer	Sales / Average number of customers	Many small businesses miss the opportunity for multiple sales by selling associated products because they don't measure and track the average customer sales results. By measuring the average customer sales the entity may become more aware of significantly improving profits every time an associated sale is made (i.e. belts with trousers, drinks with food). This is a simple way to seamlessly improving the bottom line.
	Revenue per Employee	Sales / Average number of employees	This ratio can be used to compare the entity against others in the same industry. Ideally, the entity want the highest revenue per employee possible as it indicates higher productivity and effective use of resources. Revenue per employee is affected by an entity's employee turnover rate, and turnover is defined as the percentage of the total workforce that leaves voluntarily each year and must be replaced.
	Total Cost per Employee	Total cost / Average number of employees	This ratio can be used to analyse the total cost per employee.


Bank Overdraft
Cash and Cash equivalents
Cash Sales
Credit Sales
Cost of Sales
Current portion of Long-term Borrowings
Current Tax Payable
Deferred Tax Asset
Deferred Tax Liability
Depreciation & Amortisation
Employee Costs
Goodwill
Impairments
Income Tax Expense
Interest Expense
Intangible Assets
Investments
Investment Income
Investment Property
Inventories
Loans Receivable - Long Term
Loans Receivables - Short Term
Long-term Borrowings
Long-term Provisions
Other Components of Equity
Other Current Assets
Other Current Liabilites
Other Expenses
Other Income
Other Intangible Assets
Other Non-current Assets
Other Non-current Liabilites
Property, Plant and Equipment
Retained Earnings
Revenue
Share capital/Capital Account/Members Contributions
Short-term Borrowings
Short-term Provisions
Trade Payables
Trade Receivables

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