The Calculation Of Ratios Accounting Essay

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A) Calculation of ratios

The following calculations show the analysis of the financial performance of BRITVIC PLC as at the 28 September 2008 and 27September 2009.


1) Liquidity ratios:

They measure the ability of a company to pay its current debts and unexpected expenses using current assets. Some examples of liquidity ratios are current and quick ratio. Low liquidity ratios may indicate danger of liquidity. However, some types of businesses operate on poor liquidity ratios, for example, super markets. (Wood 2005) According to Kramer & Johnson 2009, liquidity ratios seek to answer the question: how long will a company survive if it cannot pay its debts. And therefore they measure the short term success of a company. Some current ratios are treated below:-

a) Current ratio

current ratio=current liabilitiescurrent assets

For 2008

Total current liabilities= £266.50m

Total current assets= £222.20m

current ratio=222.20266.50

    Current asset = 0.83

For 2009

Total current liabilities= £303.30m

Total current assets= £277.40m

current ratio=303.30277.40

    Current ratio = 0.91:1

It is observed that the current ratio changed from 0.83 to 0.91 which is an increase by 8%. The current ratio measures the ability of the company to pay off its current debts and unexpected expenses using its current assets. For 2009, the current ratio shows that for every £1 debt to be paid within the next 12 months, Britvic has £0.91 available in the form of current assets. And for 2008, it had £0.83. The increase in the this ratio could be as a result of an increase in retained earnings from £60.0m in 2008 to £94.1m in 2009, the increase in retained earnings of one of the factors that led to an increase in the cash at bank form from £13.9m in 2008 to £39.7m un 2009. It is observed that there is an overall greater increase in the current assets of Britvic, that is by 24.8% than the there is an increase in its current liabilities, hence causing an increase in its current ratio. (Atrill & McLaney 2002)

b) Acid-test ratio (quick ratio):

Quick ratio=current assets-stockcurrent liabilities

For 2008

Total current liabilities= £266.50m

Total current assets= £222.20m

Stock= £49.50m

Quick ratio=222.20-49.50266.50

Quick ratio = 0.65:1

For 2009

Total current liabilities= £303.30m

Total current assets= £277.40m

Stock= £52.90m

Quick ratio=277.40-52.90303.30

Quick ratio= 0.74:1

The quick ratio measures the ability of a company to pay its current debts and unexpected expenses using its current assets, excluding its inventory. Inventory is excluded because it is usually difficult to convert it into cash quickly in case of urgent need of money. Within 2009, Britvic's quick ratio moved from 0.65times to 0.74times which is an increase by 5%. It can also be observed that it has more stock in 2009 than in 2008. This increase could be because in 2009, Britvic had more quick assets, that is, cash, short term investments and receivables (see values in balance sheet) than it had in 2008. (Wood 2005)


2) investment ratios:

These ratios are designed to assist investor who own shares of a company to measure their returns from investment. They also provide information which prospective investors use as a basis to decide whether or not it is worthy to invest in a company. (Atrill & McLaney 2002) Some of these ratios are treated in below:

a) Earnings per share (EPS):

It can be calculated using the following formula:

EPS=net profit after taxtotal number of ordinary shares

For 2008,

Number of ordinary shares= 214.0m

Net profit after tax= £31.8m

EPS=31.8m214.0m

Basic EPS for 2008= 14.9p

For 2009,

Number of ordinary shares= 214.9m

Net profit after tax= £46.8m

EPS=46.80m214.90m

Basic EPS for 2009= 21.8p

We notice an increase of 6.9p in the EPS as it moves from 14.9p in 2008 to 21.8p in 2009.

It represents the amount that will be allocated to each share; it is the only ratio that is required to be put in a public company's financial statement according to the GAAP. Since it is a sensitive indicator of profitability, it is closely monitored by management, investors and creditors. EPS is also a determinant of stock price. The increase in the basic EPS is as a result of a little increase in the number of ordinary share and a high in the number profit after tax. (Kramer & Johnson 2009) Therefore Britvic's stock price had a higher value as it is seen on http://ir.britvic.com/share-information/share-chart.aspx

b) Earning yield:

Earning yield=earning per sharemarket price per shareÃ-100

For 2008

Earnings per shares= 14.9p= £0.149

Market price per share as at 27/09/08= 226p= £2.26

Earning yield=14.9226Ã-100

Earning yield= 6.59%

For 2009

Earning per shares= £0.218= 21.8p

Price per share as at closing of 27/09/09= £3.59= 359p

earning yield=21.8359Ã-100

Earning yield= 6.07%

From 2008 to 2009, this ratio decreased from 6.59% in 2008 to 6.07 in 2009. This ratio determines the percentage earned from each pound invested by share holder. It is the inverse of the price earnings ratio which will be treated below. From the above ratio, it is observed that for every 100p invested, 6.59p and 6.07p were earned in 2008 and 2009 respectively. (http://www.investopedia.com/terms/e/earningsyield.asp)

c) Price earnings ratio

price earnings ratio=market price pershareEPS

For 2008

Earnings per shares= 14.9p= £0.149

Market price per share as at 27/09/08= 226p= £2.26

price earning ratio=22914.9

Price earnings ratio= 15.4:1

For 2009

Earning per shares= £0.218= 21.8p

Price per share as at closing of 27/09/09= £3.59= 359p

earning yield=35921.8

Price earnings ratio= 16.5:1

The earning yield increased from 15.4 in 2008 to 16.5 in 2009. This ratio tells how much earning an investor gets as EPS with respect to that amount he spent in purchasing it. The value of the ratio in 2008 and 2009 show that the price of a share is 15.4 and 16.5 times respectively higher than the earnings received from it. Since the value gives a measure of the company's market confidence, this implies that he in 2009, the market confidence of Britvic's share was higher in 2009 than in 2008. And therefore more investors may be willing to get shares in 2009 than in 2008. (Atrill & McLaney 2002)


3) Operating ratios:

This ratios measure the extent to which the company succeeded or failed to make profits. Profitability ratios measure the long term success or failure of a company as it answers the question: how long will a business survive if its expenses are continuously greater than its revenues. The difference between liquidity ratios and profitability ratios is that a company can be very profitable but also very liquid but is rarely insolvent and not profitable. (Kramer & Johnson 2009) Some investment ratios are treated below:

a) Net profit margin:

net profit margin=profits before tax and interetsalesÃ-100

For 2008

Sales= £926.5m

Operating profits before tax and interest= £78.4m

net profit margin=78.4926.5Ã-100

Therefore net profit margin= 8.46%

For 2009

Sales= £978.8m

Operating profits before tax and interest= £89.8m

net profit margin=89.8978.8Ã-100

Therefore net profit margin=9.17%

Britvic's net profit margin therefore increased from 8.46% in 2008 to 9.17% in 2009. This ratio provides the relationship between the net profit before tax and interest of a company and its sales. Net profit before tax and interest is used in this ratio because it is profit raised from trading. From the above ratios, for every £100 made by Britvic as sales in 2008, it made £8.46 profit. While in 2009, it made £9.17 from every £100 of sales. Some factors that affect the profitability margin of a company are: level of competition, climate, industry characteristic and type of consumers. Considering the level of competition from companies like Barr PLC, Brook Bond, Cadbury Schweppes, Coca Cola and many more, the possible reason for Britvic's low net profit margin is that he had to reduce its prices, and therefore make less profit, but increase volume of sales so as to be competitive. (Atrill & McLaney 2002)

b) Return on total asset:

return on total asset=trading incometotal assetsÃ-100

For 2008,

Trading income= £926.5m

Total assets= £741.9m

Return on total assets=926.5741.9Ã-100

Return on total asset= 125.0%

For 2009,

Trading income= £978.8m

Total assets= £853.5m

Return on total assets=978.8853.5Ã-100

Return on total asset= 114.7%

This ratio measure how efficient assets are in generating income. From 2008 to 2009, the ratios decreased from 125% to 114%. This shows that for every pound invested into the business as asset, there was £1.25 and £1.14 revenue. Therefore, in 2008, Britvic's assets were more efficient at generating profits than they were in 2009. (http://www.bizwiz.ca/return_on_assets_ratio.html)

c) Total asset turnover:

Total assets turnover=salestotal asset

For 2008,

Total asset= £741.3m
sales= £926.5m

total asset turnover=926.5741.3
Total asset turnover= 1.25times

For 2009,

Total asset= £853.5m
sales= £978.8m

total asset turnover=978.8853.5
Total asset turnover= 1.15times

This ratio measures the ability of a company to generate sales from its assets. From the above ratio, Britvic generates £1.15 and £1.25 as sales from every £1 worth asset in 2009 and 2008 respectively. Therefore, with respect to sales, Britvic was more active in 2008 than it was in 2009. The value of this ratio also depends on the company's policy, because for a company that sells less but at high prices can have a low asset turnover ratio but a higher net profit after tax and interest margin, while one like Britvic can sell more but at low prices so as to make a high asset turnover (Britvic's ratio) but a lower net profit after interest and tax margin. (http://www.investopedia.com/terms/a/assetturnover.asp) (Investopedia, 2010)

d) Debt turnover:

Debtor turnover=salesaverage debtor

For 2008

Trade and other receivables (current + non-current) for 2007= £129.8m           Trade and other receivables (current + non-current) for 2008= £155.1m Average trade and other recirvables=129.8+155.12

Therefore average debtors= £142.45m

Sales= £926.5m

Debtor turnover=926.5142.45

Debtor turnover= 6.50times

For 2009

Trade and other receivables (current + non-current) for 2009= £180.3m               Trade and other receivables (current + non-current) for 2008= £155.1m Average trade and other recirvables=180.3+155.12

Therefore average debtors= £167.7m

Sales= £978.8m

Debtor turnover=978.8167.7

Debtor turnover= 5.83times

Britvic's debtor turnover changed from 6.50times in 2008 to 5.83times in 2009. This means that in 2008 Britvic was able to collect its receivables 6.50 times in 2008 while it did 5.83times in 2009. These ratios may be misleading since the sales figure used consists mostly of cash sales. Usually a sales figure for credit sales is more appropriate for this calculation. (Atrill & McLaney 2002)

e) The stock turnover could not be calculated because the company's financial statement does not provide a figure for cost of goods sold


4) Efficiency ratios:

These ratios analyse effectiveness of the use of the company's resource. Therefore they tell how efficient the company is at using its assets to generate profits. (Atrill & McLaney 2002) Some of these ratios are treated below:

a) Equity ratio:

equity ratio=share capitaltatal assets

For 2008,

Share capital= £52.50m (this is equity shareholder's fund + share capital)

Total assets= £741.30m

equity ratio=52.50741.30

Equity ratio= 0.07times

For 2009,

Share capital= £40.90m (this is equity shareholder's fund + share capital)

Total assets= £853.50m

equity ratio=40.90853.50

Equity ratio= 0.05times

From 2008 to 2009, Britvic's equity ratio decreased from 0.70times to 0.50times. The ratio provides information about the proportion of the total asset that was acquired using share capital. In this case it is observed that for every £1 worth asset, 5p is provided by the shareholder in 2009 and 7p in 2008. (Atrill & McLaney 2002) The decrease in its value in 2009 may be because in the balance sheet, a decrease in the decrease in the equity shareholders fund was observed.

b) Debt/equity ratio:

debt to equity ratio=tatal debtshareholders fund

For 2008,

Trade and other receivables (current + non-current) for 2008= £155.1m Share capital= £52.50m (this is equity shareholder's fund + share capital)

debt to equity ratio=155.152.50

Debt to equity ratio= 2.95times

For 2009,

Trade and other receivables (current + non-current) for 2008= £180.30m Share capital= £40.90m (this is equity shareholder's fund + share capital)

debt to equity ratio=180.3040.90

Debt to equity ratio= 4.40times

This ratio Calculates how much debt the company has with respect to its shareholders fund. From 2008, the ratio increased from 2.95times to4.40 times. Therefore, in 2008, the company had 2.95tomes more debt than it had funds from shareholders, and in 2009, this figure increased and the company had 4.40times more debt than share capital. When this ratio is low, it is relatively easier for the company to obtain loans, since it gives an idea about how much the company already owes. (Atrill & McLaney 2002)

c) Debt ratio

Debt ratio=total liabilitiestotal assets

For 2008,

Total liabilities=£741.30m

Total asset= £741.30m

debt ratio=741.30741.30

Debt ratio=1time

For 2009,

Total liabilities=£853.50m

Total asset= £853.50m

debt ratio=853.50853.50

Debt ratio= 1time

This ratio provides information how much a company owes with respect to its total assets. The above calculated ratios show that in 2008 and 2009, all of Britvic's assets were finance by creditors. (Wood 2008)

The table below summarises the ratios calculated

Ratio

2008(times)

2009(times)

Observation

Current ratio

0.83

0.91

Increase

Quick ratio

0.65

0.74

Increase

EPS

14.9p

21.8p

Increase

Earnings yield

6.59%

6.07%

Decrease

Price earnings ratio

15.2%

18.1%

Increase

Net profit margin

8.46%

9.17%

Increase

Return on assets

125%

114%

Decrease

Total asset turnover

1.25

1.15

Decrease

Debtor turnover

6.50

5.83

Decrease

Equity ratio

0.07

0.05

Decrease

Debt to equity ratio

2.95

4.40

Decrease

Debt ratio

1

1

Constant


B) Overall analysis of Britvic's performance;

Out of the large number of soft drinks and carbonated drinks producer in the world, Britvic stand with flying colours. It is the second leading company that supplies in the UK and Republic of Ireland. It has renowned brands such as Robinsons, Tango, J2O, Fruit Shoot and many others which are distributed in the UK. It also has the sole permission to produce and distribute other brands such as Pepsi and 7up. (http://ir.britvic.com/~/media/Files/B/Britvic/pdfs/Britivic_AR09_finalLR.pdf)

From the above calculations, one say Britvic has had an overall good performance through the years 2008 and 2009. We observe a decrease some of the important ratios such as the equity ratio or total asset turnover ratio and some others, however the economic recession and the credit crunch could serve as explanations to these decreases. Also there was an increase in the current and quick ratios from 0.83 times to 0.91 times and 0.65 times to 0.74 times in 2008 and 2009 respectively. These can raise the point that they have fewer current assets to cover their current debt, but can also be seen as being positive if the decrease in current ratio was due to long term investments made. Some other crucial performance indicators for a company like Britvic include the following:-

In 2008, Britvic achieved a volume production of 479.6m litres, this figure increased by 3.6% as it increased to 498.8m litres in 2009.

Also, this increase in production led to growth in revenue as a 5.6% increase was observed as it increased from £926.5m in 2008 to £978.8m in 2009

Furthermore, the increase in revenue led to an increase in profit before exceptional by 13.9% from £89.8m to £110.1m in 2008 and 2009 respectively.

This led to an increase in profit allocated to ordinary shareholders, and hence an increase in EPS as seen on the table above

(http://ir.britvic.com/~/media/Files/B/Britvic/pdfs/Britivic_AR09_finalLR.pdf)

On the 28 of January 2010, Harry Bank reported on the City A.M. that Britvic achieved an 11% growth on sales in their first quarter, and that it expected this value to drop in the second because of bad weather. From the points discussed above and from Britvic's performance at the beginning of its first quarter in 2010 we can conclude that Britvic has a good performance.

Ratio analysis is a good method for performance determination, but it has some disadvantages, some of which are the following:

Firstly, the trustworthiness of the ratios depends on the quality of the financial statement. Any mistakes made in the financial statement shall eventually lead to a mistake in the ratios calculated. (Atrill & McLaney 2002)

Furthermore, some financial statements are manipulated using some accounting policies in such a way that ratios will present the company as being healthy. Therefore entities like investors and the government that make use of these ratios for decision making may be lured into making the wrong decision. This is usually known as creative accounting. (Atrill & McLaney 2002)

Also, ratio analysis does not help when comparison needed between certain types of companies. For example there is no point comparing say a company that deals with soft drinks and one that does with construction. (Wood 2005)


References:

- Internet:

Investopedia (2010) URL: http://www.investopedia.com/terms/a/assetturnover.asp, accessed on 23/01/2010

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