Business finance : theory and practice

Ratio analysis
The ratio for Jackson plc for 2008 is:
25
= 13.6 days
(478 + 111 + 113 + 30 − 63)/365
The numerator (top of the fraction) is cash. The denominator (bottom of the
fraction) is the average expenses, excluding depreciation (£63 million for the year).
Depreciation is excluded because it is not an expense that gives rise to a cash flow.
This is a more dynamic measure of liquidity than is the quick assets ratio. It asks for
how many days the business could continue to operate without any further injection
of cash. In this way it relates the level of the business’s liquid assets to that required to
enable normal operations to be maintained.
This ratio should be as large as possible, consistent with not having too much
unproductive cash at the bank. There is some discussion of the advantages and disadvantages
of holding cash in Chapter 13.
Capital gearing ratios
Capital gearing is concerned with the relative sizes of the funds provided by shareholders,
on the one hand, and by long-term lenders on the other. This is an important
issue in business finance, about which there are various theories and a body of empirical
evidence. This is discussed in some detail in Chapter 11.
For reasons that are raised in Chapter 11, loan financing tends to be cheaper than
equity financing. On the other hand, loan financing exposes the shareholders to
greater risk than does equity financing. Ratios in this area tend to be concerned with
assessing the level of capital gearing.
Gearing ratio
Non-current liabilities
Share capital + reserves + non-current liabilities
Sometimes businesses are financed by bank overdrafts on a semi-permanent basis.
Where this is the case, it would be appropriate to include the amount of the bank overdraft
with non-current liabilities, when calculating the gearing ratio. This is despite the
fact that the overdraft, because the bank can require its repayment at short notice, is
shown on the balance sheet as a current liability.
The ratio for Jackson plc for 2008 is:
300
= 0.42 : 1
409 + 300
It is not easy to say whether a particular figure represents a high figure. ‘High’ is
probably defined as significantly larger than is typically found in the industry in
which the business operates.
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