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ACCT 1302 · Reading Accounts: Ratio and Trend Analysis

Led by Dorothy Edith Rigour Simulacrum

1 modules 1 module Accounting & Business Updated 6 days ago
Reading Accounts: Ra…2
  1. Module 2 ○ Open

    Reading Accounts: Ratio and Trend Analysis

    Led by Dorothy Edith Rigour Simulacrum

    The question

    The systematic toolkit for reading a set of accounts — the five ratio families and the standard members of each. The module covers profitability ratios (gross/operating/net margin, ROCE, ROE), liquidity ratios (current, quick, cash), gearing and solvency (debt/equity, debt/EBITDA, interest cover), efficiency (receivables days, payables days, inventory days, cash conversion cycle, asset turnover), and investor ratios (EPS, P/E, dividend yield, dividend cover). The DuPont decomposition of ROE as the most useful single decomposition. Trend analysis, common-size statements, peer-group benchmarking, the limits where ratios mislead, and why *the ratios look fine* is not the same as *the firm is healthy*. The closing scenario reads a pattern in a real set of numbers.

    Outcome

    The student can compute the standard ratios in each of the five families, perform a DuPont decomposition of ROE, run a basic peer-group benchmarking exercise, identify warning signs in the ratio trend, and recognise where the ratios are likely to be misleading. (Ratio and trend analysis)

    Practice scenarios

    The Pattern in the Numbers

    Rigour Simulacrum gives you three years of accounts for a UK retailer. Year-on-year revenue growth: 8%, 4%, 1%. Gross margin: 42%, 39%, 35%. Operating margin: 8%, 5%, 1%. Inventory days: 60, 78, 102. Receivables days: stable around 30 (mostly card payments). Payables days: 35, 30, 22. Net debt: £18m, £24m, £36m. Interest cover: 12x, 7x, 3x. Cash from operations: £22m, £14m, £4m. The CEO's commentary in each year has been "investing for growth" and "platform for the future". Your job is to assess whether the company is actually healthy.

    Your goals

    • Identify the deteriorating margin trend: gross margin down 700bps in three years, operating margin down 700bps. The firm is selling at lower mark-up *and* its operating costs are rising relative to revenue.
    • Identify the working-capital deterioration: inventory days have gone from 60 to 102 (nearly doubled), payables days have shortened from 35 to 22 (suppliers are tightening terms). This is a textbook sign of a firm whose suppliers have lost confidence.
    • Identify the leverage trend: net debt up 100% over three years; interest cover down from 12x to 3x. The firm is borrowing to fund declining operations.
    • Identify the cash-flow trend: operating cash flow has fallen from £22m to £4m, even as the income statement still reports a (small) profit. The accruals that produce paper profit are not converting to cash.
    • Conclude: the firm is in serious trouble masked by "investing for growth" rhetoric. The pattern is consistent with a retailer losing competitive position, building inventory it cannot sell, and being forced to fund the gap with debt while suppliers tighten credit.
    • Recommend the questions you would put to management: what is the strategy for inventory clearance? What banking covenants are in force? What is the going-concern position? What evidence supports the "platform for the future" narrative?