From the balance sheets, it should be noted that while there was an increase in the fixed assets , a notable improvement of 19% was realised in current assets; this gives an indication of a reduction in debtors. Shareholders funds have improved, minority shareholder interest reduced, borrowings reduced and provision of other costs also reduced. The balance sheet and profit and loss accounts are essential but they only a starting point to successful financial management.
Financial ratio analysis is applied to financial statements to analyse the success, failure and progress of the business. Financial ratio analysis is the calculation and comparison of ratios derived from the information in a company’s financial statements. The level and trends of these ratios can be used to gauge a company’s financial condition, operations and attractiveness as an investment.Balance sheet ratios measure liquidity and solvency (the ability of the business to pay their bills) and leverage (the extent to which the business depends on creditors funding).
Balance sheet ratios include: Liquidity ratios; they indicate the ease of turning assets into cash and include the current ratio, quick ratio and working capital. Current ratio = Total current Assets /Total current liabilities = 6,108/12,260 = 0.50In cases where the value is greater than unity, current assets value exceeds current liabilities. In the case of British American Tobacco, the value of the current liabilities is more than the value of current assets. British American Tobacco should increase current assets from new equity contributions, pay some debts convert non current assets into current assets and put profits back into the business.Quick Ratio: The Quick ratio is a much more exacting ratio than the current ratio. By excluding inventories, the quick ratio concentrates on the liquid assets whose value is certain.
The quick ratio answers the question of whether the establishment can meet its current obligations with the readily convertible quick funds on hand in the event that the sales revenue disappears. The calculation of the quick ratio excludes the value of stock so as to show the immediate solvency of the company.Quick Ratio = Current Assets- Stock This represents the proportion of capital employed that is made up by shareholder’s funds. In the case of British American Tobacco, the company heavily relies on equity finance to for its activities. Investment ratios: Ratios such as dividend payout ratio are of great interest to investors. The dividend payout ratio for British American Tobacco is only 5% dividend which could be attributed to British American Tobacco’s focus on developing new products, new processes as well as maintain the quality of the existing products thus their profits are better spent in reinvesting than as a cash pay out to shareholders.In conclusion therefore, the different ratios analysed above, allow the business management to identify trends in the business and compare its progress with the performance of others through data published.
It is then that the company management determine the business’s weaknesses and strengths.References:Bandler James, How to Use Financial Statements: A guide to understanding the numbers, 1994 Barr Elliot , Jamie Elliot, Financial Accounting and Reporting, sixth edition (2002) British American Tobacco – Report 2004