Extended Analysis

Gross Profit %

Definition

Gross profit % represents a business's gross profit (sales less cost of goods/services sold) divided by its sales revenue (expressed as a percentage); that is, it is the average markup a business applies to the cost of its products/services.

Implications

The gross profit % provides an indication of how profitably a business can sell its products/services. Note that while a higher gross profit margin (%) is typically better than a lower margin, too high a margin can result in lost sales (revenue) and this, in turn, can impact a business's overall profitability and, ultimately, the business's notional value. It is therefore important that business owners monitor their gross profit margins to ensure they are in line with their key competitors.

EBIT %

Definition

EBIT % represents a business's earnings (profit) before interest and taxes divided by its sales revenue (expressed as a percentage). It provides an indication of the before-tax profitability of a business excluding income/expenses not directly related to the core activities of the business (e.g. extraordinary items and interest).

Implications

The EBIT % provides an indication of the overall operating performance of a business and because it separates out a business's operating activities from its financing activities, it is helpful in comparing businesses that have different capital structures and/or tax obligations. Investors and creditors (including banks) typically monitor this performance indicator because it provides a useful guide to how well a business's core operating activities are performing and the business's future scalability. A business with a positive trend in its EBIT margin (%) will typically have a greater capacity to fund future growth.

Working Capital %

Definition

Working capital % represents a business's working capital divided by its sales revenue (expressed as a percentage). Working capital is calculated as current assets (e.g. debtors and inventory) less current liabilities (e.g. creditors).

Implications

Working capital % provides an indication of how well a business is utilising its working capital to support its current level of sales. Other things being equal, the less money tied up in working capital the better. However, it is important for a business to have sufficient working capital: to ensure it can pay its bills (creditors) on time and to limit the number of lost sales due to inventory shortages.

Cash Conversion Cycle

Definition

The cash conversion cycle provides an indication of how long (in days) it takes a business to convert its investment in inventory into cash. The cash conversion cycle is the sum of the business's average inventory days plus its average debtor days less its average creditor days. These three components are calculated as follows:

The business's average inventory is divided by cost of goods sold and then multiplied by 365 to provide an estimate of the number of days of inventory the business has on hand;

The business's average debtors figure (accounts receivable) is divided by sales revenue and then multiplied by 365 to provide an estimate of the number of days it is likely to take for the debtors to be converted into cash; and

The business's average creditors figure (accounts payable) is divided by cost of goods sold and then multiplied by 365 to provide an estimate of the number of days in outstanding creditor payments the business has.

Implications

The cash conversion cycle essentially provides an estimate of how long (in days) it takes a business to receive cash from its customers following the payment to creditors for the purchase of inventory. A shorter cash conversion cycle means that a business's money is tied up in inventory and debtors for a shorter period of time. Businesses should regularly monitor their cash conversion cycle to ensure they are being as efficient as possible in terms of not carrying excess inventory and ensuring their debtors are paying on time.

Fixed Asset Investment

Definition

Fixed asset investment represents the net investment by a business in fixed assets and is calculated by adding the depreciation expense for the period to the closing book value of fixed assets and then subtracting the opening book value of fixed assets.

Implications

It is important to review fixed asset investments because the purchase of a new fixed asset can potentially cause a deterioration in a business's operating asset turnover until such time as the business is able to generate additional sales to reflect the increased investment in its operating assets. Conversely, if a fixed asset is sold this could artificially inflate a business's operating asset turnover.

Altman Z-Score

Definition

The Altman Z-score is used to measure a company’s financial health (and to predict the probability that a company will collapse within 2 years) through a combination of various ratios. Studies have shown that the Altman Z-Score model has a 72% – 80% reliability score in predicting business bankruptcy.

Implications

The Z-Score is an important measure in determining the financial strength of a company as it relies on several different ratios. The lower a business's Z-Score the more likely it is to become insolvent/bankrupt. Note, however, that one of the ratios used to determine a business's Z-score relies on the business's retained earnings and, therefore, some caution must be exercised in interpreting a business's Z-score where the business has only recently been established and has not had the opportunity to generate retained earnings.

Interest Cover Ratio

Definition

The interest cover ratio is calculated by dividing EBIT by interest expense. This ratio provides an indication of a business's ability to make interest payments on its debt in a timely manner.

Implications

Creditors and investors will often use the interest cover ratio to gain a better understanding of a business's risk profile. Thus, investors want to see that their company can pay its bills on time without having to sacrifice its operations and profits. Note that a ratio less than 1 means that a business isn’t generating sufficient earnings to cover its interest payments; let alone make any principal repayments. Financial institutions will often use the interest coverage ratio to identify whether a company is able to support additional debt.

Current Ratio

Definition

The current ratio is calculated by dividing current assets by current liabilities and indicates a business's ability to pay off its short-term liabilities using the cash flow generated from current assets.

Implications

The current ratio helps investors and creditors better understand a business's liquidity and the likelihood that it will be able to pay its current liabilities as and when they fall due. A ratio above 1 indicates that a business's current assets exceed its current liabilities and, therefore, it is likely the business will be able to meet its future current liability commitments. Note, however, that the appropriate current ratio for a particular business will depend on the nature of that business (e.g. the industry in which it is operating) and there is no particular value that is optimal for all businesses.

Free Cash Flow

Definition

Free cash flow (FCF) is calculated as the sum of the cash flows generated from a business's operating, investing and financing activities (excluding any dividend payments).

Implications

A positive FCF is normally a good sign as it indicates that a business is able to both fund its activities and have cash available to make dividend payments. However, it should be noted that a business could generate a positive free cash flow because it has failed to adequately maintain/replace equipment. If this continues, the existing equipment is likely to break down, potentially disrupting a business's operations. Conversely, a negative free cash flow might simply mean that the business is investing heavily in new equipment, which will boost the business's future performance.

Payout to FCF Ratio

Definition

The payout to free cash flow ratio is calculated by dividing any dividend payments during the period by the business's FCF (expressed as a percentage).

Implications

This ratio indicates the proportion of free cash flow a business has elected to retain (possibly to fund future growth or to help protect the business in the event of an economic downturn) as opposed to paying dividends to the owners/shareholders.

Extended Monthly/Quarterly Analysis

This analysis page provides some of the metrics from the extended annualised analysis page but on a monthly and quarterly basis.