Using ratios to analyse companies

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3. The P&L and the balance sheet

The two main sources of numbers in a set of report and accounts come from:

• the profit and loss account
• the balance sheet

Profit and Loss Account

This summarises the result of last year's trading in figures. It tells you what the company sold, what its costs were, how much profit it made, what the tax charge was, what was left for shareholders, and how much of this is being paid out to them in dividends and how much ploughed back into the company. It also gives comparable figures for the previous year.

The P&L supplies many of the hard numbers used in ratio analysis, particularly those relating to operating efficiency.

Balance Sheet

This provides a snapshot of everything the company owes and owns at the end of the financial year in question. It tells you what its assets are and how they are financed. Where the P&L tells you how the company has performed in the previous year, the balance sheet reveals things about its fundamental health, like whether it can pay its debts and how good its cash management is.

Significance: if the company is having problems, the balance sheet (together with the cash flow statement) will tell you whether it can stand the strain.

Example

Below are a simplified P&L account and balance sheet from Marks and Spencer plc's accounts for the year ending 31.3.95:

Total interest received was £181m of which £119m is excluded because it related to the finance activities, leaving £62m relating to trading activities credited to the P&L.

The total interest paid was £66m, of which £37m is excluded because it related to the finance activities, leaving £29m relating to trading activities charged against the P&L. The £33m credit shown in the P&L is the difference between the £62m credit and the £29m debit.

Notes:

1. Current liabilities include £247m of short term borrowings, and £175m of trade creditors
2. Short term debtors of £578m include £33m of trade debtors
3. End of year stock is £377m
4. Shareholders' funds of £3,714 include £21m of Minority Interests

1. Why bother with ratios? 2. A word of warning 3. The P&L and the balance sheet 4. Grouping the ratios 5. Profit margin 6. Return on capital employed (ROCE) 7. Sales as a multiple of capital employed 8. Stockturn 9. Debt collection 10. Payment of trade creditors 11. Cash-to-cash cycle 12. Gearing 13. Interest cover 14. Current ratio 15. Quick ratio (acid test) 16. Earnings ratios 17. Dividend ratios 18. Other ratios 19. Sources of information 20. Conclusion

• Magic Numbers