Financial Ratios: How to use financial ratios to maximise value and success for your business'.

193 Pages·2007·1.06 MB·English

by  Richard Bull

Financial Ratios
How to use financial ratios
to maximise value and success
for your business
Richard Bull
AMSTERDAM•BOSTON•HEIDELBERG•LONDON
NEWYORK•OXFORD•PARIS•SANDIEGO
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Contents
List of Figures and Tables v
Foreword vii
Acknowledgements viii
About the Author ix
Introduction: The place of financial ratios in
business success xi
PART ONE The Role of Financial Ratios 1
1 Creating value – a model of success 3
2 Measuring value – the origin of financial C
o
ratios 17 nte
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ts
PART TWO Understanding Financial Ratios 33
(cid:2)
iii
3 Funding management – the gearing
ratio 35
4 Asset management – the asset
turnover ratio 45
5 Value add management – the profit margin 61
6 Tax management – the effective
tax rate 77
7 Growth management – the payout
and retention ratios 87
PART THREE Using Financial Ratios 99
8 The composite ratios 101
9 The place of financial ratios in strategic
management 115
10 Perspectives on financial ratios 131
Appendices 143
Appendix 1 The purpose of ratios: The
three Eff’s 145
Appendix 2 The source and application of
financial data for ratio analysis 149
Appendix 3 A benchmarking example 157
Appendix 4 Further reading 163
Index 167
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(cid:2)
iv
List of Figures and Tables
Figures
I.1 The three Eff’s xv
I.2 The components of a process xvi
I.3 The Enterprise Stewardship Model xvii
1.1 Strategic management 6
1.2 Funding management 7
1.3 Asset management 8
1.4 Value add management 11
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1.5 Tax management 12 ist
o
f
1.6 Growth management 14 F
ig
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2.1 Business as a process for measurement 20 re
s
2.2 The strategic ratios 21 an
d
2.3 The gearing ratio 22 Ta
b
2.4 The asset turnover ratio 23 les
2.5 The profit margin 24
(cid:2)
2.6 The effective tax rate 25 v
2.7a The retention ratio 26
2.7b The payout ratio 26
2.8 The financial ratios 27
2.9 The composite ratios 28
3.1 Funding management 38
4.1 Asset management 47
4.2 Analysis of assets on the balance sheet 50
4.3 Classes of assets 57
5.1 Value add management 64
5.2 The relationship between profit and value added 65
5.3 Two approaches to cost management 67
5.4 Three approaches to profit management 68
5.5 Alternative ways of doubling your profit margin 70
5.6 The enterprise value chain 73
6.1 Tax management 81
7.1 Growth management 90
7.2 Techniques of investment appraisal 93
8.1 Benchmarkingresultsandprocessesforyourbusiness 104
8.2 The return on assets ratio 107
8.3 The return on equity ratio 108
8.4 The dividend yield 109
8.5 The composite ratios 111
9.1 The strategic management ratio 118
9.2 Five steps in the strategic management process 119
9.3 Checking the foundations 125
9.4 Strategic building maintenance 126
10.1 The customer and supplier perspectives on
the profit margin 136
10.2 The employee perspective on ROA 137
10.3 The community perspective on after-tax ROA 138
10.4 The shareholder and entrepreneur perspectives
on yields 140
es 10.5 Theleadershipperspectiveonrolesandrelationships 141
bl
a
T A2.1 The source of financial data for ratio analysis 152
d
n
a A2.2 The application of financial data for ratio analysis 152
es
ur A2.3 Worked example: A jewellery group 154
g
ofFi A2.4 Worked example: An international oil company 155
List A3.1 Benchmarking example – selected company data 159
A3.2 Benchmark mapping 160
(cid:2)
vi
Tables
A1.1 The Three Eff’s – Definitions 147
A1.2 The Three Eff’s – Examples 148
Foreword
A key element in the difference between success and failure in
business start-ups is the ability of entrepreneurs to come to grips
with the financial aspects of the business. Relatively few compa-
nies are started by accountants, and the sorts of people who have
entrepreneurial drive are unlikely to regard financial ratios as an
absorbing subject.
Henceitisimportantthatbooksonthesubjectshouldbeeminently
readable and present the necessary information in such a way as to
give it a ‘story line’.
This Richard Bull’s book does extremely well, putting ratios in the
context of the successive stages of building a business, from the
original idea, through the formulation of strategy to the realisation
F
of added value. He concludes by looking at financial ratios from ore
w
the perspectives of the different stakeholders – the customers, the o
rd
employees, the suppliers, the community and the shareholders.
(cid:2)
The author does remind us, however, of the dangers inherent in vii
measuring business success through financial ratios alone.
I would strongly recommend this work as essential reading, not
onlyforbuddingentrepreneurs,butforallthosefromnon-financial
backgroundswhosecareerpathstakethemintojobsthatcarryprofit
responsibility. It will also be of value to business studies students
as a ‘crammer’.
Philip Sadler CBE
formerly Chief Executive of Ashridge Management College
Acknowledgements
Thankyoutothosewhohavecontributedtothisbook.Itrepresentsa
furtherstepinrealisingavisionforrevealingtheessenceofbusiness
and what it means to all those engaged in it. In particular, I would
like to thank:
David Auger BSc FCA;
Neil Austin BSc FCA MSI, Partner at KPMG and Global Head of
Markets;
Dr David Hillson FRSA FAPM FIRM FCMI, Director of Risk Doctor
and Partners; and
ntsnts GordonB.F.McKayMIOM,ManagingDirectorofGBFMConsulting
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wlewle fortheircommentsandamendmentstotheoriginaldraft.Theyhave
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My thanks too to Andrew Boyd for his help in producing the intro-
(cid:2)(cid:2) ductory video for the CD-ROM included with this book.
vviiiiii
About the Author
RichardBullgraduatedinPolitics,PhilosophyandEconomicsfrom
OxfordUniversitybeforequalifyingasanaccountantwiththeChar-
tered Institute of Management Accountants (CIMA). He draws from
his experience in a number of financial management positions in
manufacturing and financial services over twenty years, including
managementconsultancyassignmentsacrossavarietyofindustries.
He is also a member of the Institute of Business Consulting (IBC).
Richard has written for a number of professional journals on many
aspectsoffinancialmanagementandperformancemeasurementand
receivedanawardfromtheInternationalFederationofAccountants
for his ‘distinct and valuable contribution to the advancement of
management accounting’. AAA
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He can be contacted via the publishers or through e-mail at ttt
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[email protected] AAA
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