Choosing The Best Audit And Taxation Services For Your Company

By Author: Karin Rocha
Total Articles: 164
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If we were look at a balance sheet or profit and loss account, how would you decide whether the company was doing well or badly? Or whether it was financially strong or financially vulnerable? And what would be you looking at in the figures to help you to make your judgment?

Within each heading we will identify a number of standard measures or ratios that are normally calculated and generally accepted as meaningful indicators.

Each individual business must be considered separately, and a ration that is meaningful for a manufacturing company may be completely meaningless for a financial institution. Try not to be too mechanical when working out ratios and constantly thinks about what you are trying to achieve.

They key to obtaining meaningful information from ratio analysis is comparison. This may involve comparing ratios over time within the same business to establish whether things are improving or declining, and comparing ratios between similar business to see whether the company you are analyzing is better or worse than average within its specific business sector.

In case, ...
... consider also who you are advising, a creditor will not be interested in shareholders investment ratios.
It is impossible to assess profits or profit growth properly without relating them to the amount of funds (capital) that were employed in making the profits. The most important profitability ratio is therefore return on capital employed, which states the profit as a percentage of the amount of capital employed.

Return on capital employed = Profit on ordinary activities before interest and taxation / Capital employed
The underlying principle is that we must compare like with like, and so if capital means share capital and reserves plus long term liabilities and debt capital, profit must mean the profit earned by all this capital together. This is profit before interest and taxation, since interest is the return for loan capital.

What does a company return on capital employed tell us? What should we be looking for? There are three comparisons that can be made.
• The change in return from one year to the next can be examined
• The return being earned by other companies, if this information is available, can be compared with the return on capital employed of this company.

• A comparison of the return with current market borrowing rates may be made.

1. What would be the cost of extra borrowing to the company if it needed more loans, and it is earning a return on capital employed that suggests it could make profits to make such borrowing worthwhile?

2. Is the company making it which suggests that it is getting value for money from its current borrowing?

3. Companies are in a risk business and commercial borrowing rates are a good independent yardstick against which company performance can be judged.

However, it is easier to spot a low ratio, than a high one, because there is always a chance that the companies fixed assets, especially property, is undervalued in its balance sheet, and so the capital employed figure might be unrealistically low.

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