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Financial retios 2

A. Profitability

There are various profitability ratios that allow investors to compare a company’s profit with its sales, its assets or its capital. Financial analysts usually include them in their reports on companies.

This is the gross profit margin. It is the money a company has left after it pays for the cost of the goods or services it has sold. A company with a higher gross profit margin than competitors in its industry is more efficient, and should be able to make a profit in the future.
net profit This is return on assets. It measures how efficiently the firm’s assets are being used toralassess to generate profits.
This is return on equity (ROE). It shows how big a company’s profit is (after interest and tax) compared with the shareholders’ equity or funds.

B. Leverage 

This is gearing or leverage, often expressed as a percentage. It shows how far a company is funded by loans rather than its own capital. A highly geared or highly leveraged company is one that has a lot of debt compared to equity.

This is interest cover or times interest earned. It compares a business’s annual interest payments with its earnings before interest and tax, and shows how easily the company can pay long-term debt costs. A low interest cover (e.g. below 1.0) shows that a business is having difficulties generating the cash necessary for its interest payments.

16.1 Match the two parts of the sentences. Look at A and B opposite to help you.

1 After borrowing millions to finance the takeover of a rival firm, the company’s
2 Although sales fell 5%, the company’s

3 Like profit growth, return on equity is a measure of

4 With just 24% gearing, the company can afford

a gross profit margin rose 9% from a year ago, so senior management isn’t worried.
b how good a company is at making money.

c interest cover is the lowest it has ever been.

d to acquire its rival, which would help to increase its steady growth.

16.2 Read the text and answer the questions below. You may need to look at Units 11-14.

Predicting insolvency: the Altman Z-Score

The Z-Score was created by Edward Altman in the 1960s. It combines a set of 5 financial ratios and a weighting system to predict a company's probability of failure using 8 variables from its financial statements.

The ratios are multiplied by their weights, and the results are added together.

The 5 financial ratios and their weight factors are:

A               EBIT / Total Assets                                                                                           x 3.3
B              Net Sales / Total Assets                                                                                    x 0.999
C              Market Value of Equity / Total Liabilities                                                           x 0.6
D              Working Capital / Total Assets                                                                          x1.2
E              Retained Earnings / Total Assets                                                                      x 1.4

Therefore the Z-Score = A x 3.3+B x 0.999+C x 0.6+Dx1.2+Ex 1.4

Interpreting the Z-Score

> 3.0                            - based on these financial figures, the company is safe

2.7-2.99                       - insolvency is possible

1.8-2.7                         - there is a good chance of the company going bankrupt within 2 years
<1.80                            - there is a very high probability of the company going bankrupt

Which ratio in the Z-Score takes into account:

1 money used for everyday expenses?

2 undistributed profits belonging to the shareholders?

3 income or earnings before interest and tax are deducted?

4 the current share price?

5 the amount of money received from selling goods or services?