Financial measures

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Financial measures or financial ratios are often used as very simple mechanisms to describe the performance of a business or investment. Because they are easily calculated they can not only be used to compare year on year results but also to compare and set norms for a particular type of business or investment.

However, comparing businesses and investments just by considering a single measure is impossible. Also the nature of an investment or type of company can be very different as can the risk involved for the investment.

Contents 1 Performance 2 Turnover 3 Liquidity 4 Gearing 5 Employee 6 Other

Performance

• Profit/Sales (%) - Percentage of sales left as profits or losses before tax, also known as the Profit Margin. Therefore a higher result, higher profitability. Reductions in this figure over time might indicate a need to re-evaluate sales pricing or supplier costs, or a need to reduce operating expenses.
• Profit/Capital Employed (%) - Indication of how much profit a business yields relative to the money invested, also referred to as Return on Capital. This is often used as a primary measure of company performance. This indicator shows simply whether an investor might be better keeping his money in a bank as its simple equivalent for an investment would be interest rate
• Profit/Total Assets (%) - Shows as a percentage the value of the pre-tax profits in proportion to the value of total assets. Very similar to the measure above except it ignores tax and borrowing rates. Useful to middle management of a company as they have no control over these issues.
• Profit/Shareholders Funds (%) - Proportion of pre-tax profit made in relation to the value of shareholders funds. Used to discriminate profits made ignoring any profit on borrowed funds.

Turnover

• Sales/Total Assets (%) - Shows as a percentage the value of sales in proportion to the value of total assets as a percentage. Also referred to as Asset Utilisation. Very different for different business types, compare a book shop with a fruit merchant for example.
• Sales/Fixed Assets - Shows as a ratio the value of sales in proportion to the value of fixed assets. Useful in some types of business where the fixed assets are large (Hotel chains, Department stores) or may have alternate uses.
• Working Capital/Sales (%) - Surplus or deficiency of funds from normal trading activities in relation to its size measured by sales. This measure is also very different for different type of company and the bookshop v fruit business example holds good.
• Stock Turnover - Turnover divided by stocks held - number of times stock is renewed each year.
• Credit Period (days) - Number of days, on average, for the company to collect trade debt. Calculated by dividing Trade Debtors by Sales and multiplying by 365 days.
• Creditor Days (days) - Number of days for company to pay trade creditors and therefore an indication of the amount of credit given to the business by its suppliers. The formula is trade creditors divided by sales multiplied by 365 days.

Liquidity

• Current Ratio - Represents no. of times company’s short term assets cover its current liabilities, it therefore measures it’s ability to meet its day to day commitments.
• Liquidity Ratio - Represents no. of times a company's quick assets can cover its current liabilities. Quick assets defined as current assets less stock. Allows a reasonable amount of time for stock to be converted into cash.

Gearing

• Total Debt/Net Worth (%) - Measures gearing or leverage of company by comparing total loans (short and long term) to net worth.
• Shareholders Funds/Total Assets (%) - Relationship between company’s assets to shareholders funds.
• Long Term Debt/Net Worth (%) - This represents the debt outstanding beyond 12 months in relation to net worth.
• Interest/Pre-Interest Profit (%) - Sometimes referred to as Income Gearing - measures the proportion of pre-interest profit which is required to service debt.
• Total Debt/Working Capital - Gearing measurement which compares total borrowings with the surplus or deficit of funds from normal trading activities.

Employee

• Average Employee Remuneration- Employee remuneration divided by the average number of employees.
• Wages/Sales (%) - Indicates amount of sales revenue expended on employees pay, showing the marginal cost of employment.
• Profit/Employee - Amount of profit before tax made per employee.

Sales/Employee - Often used as a measurement of productivity, indicates amount of sales revenue generated by each employee.

• Capital employed per Employee - Capital employed (sum of shareholders funds and Total Long Term Liabilities) per employee.
• Fixed Assets/Employee - Fixed Asset investment per employee.
• Total Assets/Employee - Total Assets in comparison to the number of employees.

Other

• Creditors/Debtors - Ratio of trade creditors to trade debtors.

Debtors/Total Assets (%) - Measures value of monies owed in relation to company’s asset base.

• Exports/Sales (%) - Amount of sales revenue attributable to export business as a percentage of total sales.
• Sales/Audit Fees - Comparison of sales revenue to cost of audit.

Total Assets/Audit Fees - Comparison of total assets to audit fees.