Chapter 6: Key accounting ratios and measures for the capital markets

Chapter 6: Key accounting ratios and

measures for the capital markets

6.1 Introduction
In order to assess an organisation’s potential, an analyst must understand
the company strategy, assess whether that strategy is achievable and
identify the risks if assumptions change.
As such, it should be possible to read financial statements in the context
of a company’s stated strategy and goals and see how those goals are
reflected in both financial performance and stability.
The most well-established methodology for analysing financial statements
is to use ratios. Importantly, ratio calculations means very little in
themselves. It is only by comparing such analytical measures to history
or to (say) industry peers or averages that we can begin to draw some
interesting insights.
This material may be familiar to you from earlier studies. However there
are certain elements specific to capital market participants that you may
not have encountered before; they will form the most important part of
the chapter.

6.1.1 Learning outcomes

By the end of this chapter, and having completed the Essential reading and
activities, you should be able to:
• explain key metrics which are used to analyse company performance
and the importance of analysing operations
• calculate key metrics from company to company which will allow for
comparison of performance
• analyse how a company’s strategy and market position are reflected
within the financial metrics.

6.1.2 Essential reading

Palepu, K., P. Healy and E. Peek Business analysis and valuation. (Cengage
Learning EMEA, 2022) 6th edition. Extracts from Chapter 5.

6.1.3 Further reading

Lee, K. and D. Taylor Financial statement analysis under IFRS. (Financial Edge
Training, 2018) 6th edition. Chapter 6.

6.1.4 References cited

Sainsbury’s plc Annual Report 2022, www.about.sainsburys.co.uk/investors/
results-reports-and-presentations
Tesco plc Annual Report 2022, www.tescoplc.com/investors/reports-results-
and-presentations/annual-report-2022/
Best Buy Co. Inc, Form 10-K, 2021, https://www.sec.gov/Archives/edgar/
data/764478/000076447821000024/bby-20210130x10k.htm
Harvey Norman Holdings Ltd, Year-End Report, June 2021, http://clients.
weblink.com.au/news/pdf/02415189.pdf

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6.2 The foundations of ratio analysis

Ratio analysis involves comparing one number from the financial
statements with another, with the aim that the resulting figure will give
some crucial insight into performance, position, stability or liquidity of
a company. As stated above, looking at such a relationship for just one
company, or for one period in isolation, gives very little insight. Only when
the relationships are analysed with respect to previous accounting periods,
other similar firms across the industry or against an expected/required
benchmark, do ratios show their true value.
You should be aware that there are no regulations, standards or rules
which define ‘ratios’; any relationship which gives insight into a set of
financial statements can be useful for a user of accounts. That said, there
are some common metrics which are used when attempting to understand
a company’s performance within common categories.
Note: when performing ratio analysis, you must take care to use financial
information that is robust and reliable. Scepticism about financial
statements is explored more in Chapters 9 and 10 of this course.

6.2.1 Profitability, performance and growth

When analysing financial statements, you are likely to encounter the
following key metrics.

Return on Equity (ROE) Using accounting measures, this relationship gives an

profit after tax indication of how much return is being generated for
ROE = shareholders compared to the finance which equity
shareholders ′ equity
investors have invested in the company.
It is useful to compare this from year to year to see if
a company is using equity finance wisely and offering
growth. Alternatively, this value can be compared
with other companies to indicate whether the first
company offers better returns than competition
within the same industry.
Investors can also look at this metric to see if
it meets their own minimum requirement when
compared to the risk taken on investing in such a
company.
Return on Equity can be decomposed into further ratios, which can give
greater insight into what drives the company’s ROE. One such method is
the Dupont decomposition.
Return on Equity = Net profit margin × Asset turnover × Asset to equity

Profit after tax profit after tax sales total assets

= × ×
Shareholders’ equity sales total assets shareholders’ equity

Note that the rules of multiplication mean that the sales cancel each other
out in the first two terms, and the total assets cancel out in the last two
terms, leaving the original calculation: ‘Profit after tax/Shareholders’ equity’.

Net profit margin: The net profit margin indicates, for every $1 of sales made, how
much is left as profit once all costs have been incurred (including
profit after tax
interest and tax expenses).
sales
The higher this percentage, the more a company appears to be
able to control costs compared to the premium charged on sales.

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Asset turnover: The asset turnover gives an indication of the success a company
can have in utilising its assets to generate sales.
sales
total assets The higher the number, the more sales the company is able to
generate from every $1 invested in assets.
Asset to Equity: This ratio gives a little insight into the source of finance being
used to fund a company’s operations.
total assets
shareholders’ equity A company’s assets must be funded from a combination of debt
and equity finance. Therefore, the higher this number is, the
more debt finance a company must be using to fund its assets,
and hence its operations.
Conversely, the closer this number is to 1, the more equity
finance is being used instead.

Worked example 6.1

Consider the following two companies and their respective data.

Noble Inc. Gentry GmBH

Sales $30.0m $35.0m

Profit after tax $1.2m $2.5m

Total assets $10.0m $29.2m

Shareholders’ equity $8.3m $17.2m

Other finance $1.7m $12.0m
$10.0m $29.2m
Using this data, we can see that the return on equity appears similar for both
companies:

Noble Inc. Gentry GmBH

ROE $1.2 $2.5

= 14.4% = 14.5%
$8.3 $17.2
But upon further decomposition, we can see that the companies are
achieving this in different ways.

Noble Inc. Gentry GmBH

Profit margin 4.0% 7.0%
× Asset turnover 3.0 times 1.2 times
× Asset to equity 1.2 times 1.7 times
= ROE 14.4% 14.5%
These calculations show that the main driver of Noble Inc’s ROE is high
asset turnover. As such, Noble Inc is able to generate higher than normal
revenue from their assets. In other words, the company uses its assets more
effectively to generate revenue. This can be interpreted as a measure of
efficiency.

Gentry GmBH on the other hand, generates revenue less effectively; it

achieves a 14.5% ROE by focusing on cost control, as evidenced by the
higher profit margin. Also assisting the ROE is the fact that Gentry GmBH
utilises more debt to generate performance. This debt appears to be
serviceable as evidenced by the higher profit margin.

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6.2.2 Efficiency of utilising resources

Asset management is a key indicator of a firm’s effectiveness in utilising
the resources which have been made available to it. We touched on this
type of analysis above, when looking at the turnover of total assets in the
ROE decomposition. The focus of this analysis is not necessarily on profit,
but instead on the effectiveness with which management use resources.
This can be assessed by looking at working capital (i.e. current assets less
current liabilities) as well as non-current assets.

Net working capital to This ratio allows users of accounts to see how many
sales: cents need to be invested in working capital per $ of
revenue generated.
net working capital
revenue The lower this ratio, the more effectively a company is
utilising its short term resources.

Net working capital Conversely, net working capital turnover tells us how
turnover: many $ of revenue are generated for every $ invested
into working capital.
revenue
net working capital This tells us the same information but from a different
angle. Here, a higher number suggests that a company
is better at utilising its short term resources.
Days receivable: This ratio gives an indication of how successful a
company is at collecting cash after the point of sale.
accounts receivable × 365 days
revenue This figure represents the average time taken for the
company to collect debt. The shorter this time period
is, the quicker a company is at realising cash after a
sale.
Days payable: Similar to days receivable, this ratio indicates how long
an organisation takes, on average, to pay its suppliers.
accounts payable × 365 days
cost of sales It could be argued that the longer this ratio is, the
more effectively a company is managing its working
capital. This is because, the longer this period is, the
longer finance is retained inside the business before
being used to settle a liability.
Inventory days: This ratio gives an indication of how long a firm takes
to sell an ‘average’ item of inventory.
inventory × 365 days
cost of sales Shorter numbers indicate that a firm is effectively
turning over inventory more quickly and is therefore
being more efficient with its resources.

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Worked example 6.2

Look at these extracts from a company’s financial statements:

£’000 £’000
Revenue 3,200 Trade receivables 260
Cost of sales 1,900 Inventory 180

Gross profit 1,300 Trade payables 235

260
Receivable days =  365 = 29.7 days
3200

180
Inventory days =  365 = 34.6 days
1900
235
Payable days =  365 = 45.1 days
1900
This company takes approximately 34.6 days to sell inventory, and then
29.7 days to receive cash from customers. Therefore, in total, it takes 64.3
days for the company to turn an average purchase of inventory into cash
received.

In comparison, the company is paying for those supplies after an average of

45.1 days.

This suggests that the company needs to finance 19.2 days worth of
operations from its own sources of finance. This is known as the ‘cash
conversion cycle’ (sometimes referred to as the working capital cycle).

Cash conversion cycle = Receivable days + Inventory days – Payable days

6.2.3 Liquidity ratios

Liquidity ratios allow users to understand the financial stability of an
organisation, by considering whether the organisation is able to meet its
current obligations with the resources which are available to it. The higher
the ratio, the more likely it is that an organisation can continue to trade
comfortably.

Current ratio: This ratio simply looks at assets which are likely to be
realised into cash within the next twelve months (i.e.
current assets
utilised to meet forthcoming obligations). A value greater
current liabilities
than 1 suggests that the company should be able to meet
obligations as long as its current assets can be realised.
Quick ratio: This ratio is very similar to the current ratio. However, it looks
at whether the organisation can meet its current obligations
current assets – inventory
without the need to sell inventory (since inventory is
current liabilities
considered to be the least liquid of current assets).
Again, a value greater than 1 suggests a more financially
stable organisation.
Cash ratio: This takes the previous ratios one step further and assesses
whether an organisation is able to meet its current
cash and cash equivalent
obligations from cash reserves. This removes the need to
current liabilities
realise cash from other current assets.
Once again, a value of 1 can act as a benchmark for a
company which is more financially stable.

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6.2.4 Long term solvency

Beyond short term survival, it is important for many market participants to
understand whether a firm is likely to survive in the long term. One way
to assess this risk is to consider the sources of long-term finance that an
organisation uses/relies upon and assess whether the obligations which
come with this can be met by the organisation.

Debt to Equity ratio: These two ratios, although different,

offer the same analysis. They reflect the
total debt
reliance upon debt compared to equity
shareholders’ equity
sources of finance.
Since sources of debt finance carry the
Debt to Capital ratio obligation to meet finance payments,
total debt higher values may indicate a company
total debt + shareholders’ equity which is at greater risk of being unable to
meet these payments.

Interest cover (earnings method): When coupled with the ratios above,
these interest cover ratios give further
operating profit
insight into whether a company is
finance expense
generating sufficient income from
its performance to meet financial
Interest cover (cash flow method): obligations. As this number approaches
1, an organisation is at greater risk of
cash flow from operations (before interest)
defaulting on required payments.
interest paid

Activity 6.1
Read the following sections from Palepu et al. (2022):
• Introduction
• Ratio analysis
• Measuring overall profitability
• Decomposing profitability: Traditional approach
• Evaluating investment management: Decomposing asset turnover
• Evaluating financial management: Financial leverage

6.3 Isolating operational analysis

In finance, we generally like to separate operating analysis from the
analysis of capital structure (i.e. the chosen mix of debt and equity). This
is because the two analyses are very different in nature. For example,
assessing an airline’s operations entails looking at issues such as airport
hubs, fleet management and pricing mix. In contrast, exploring capital
structure ignores these issues and looks at the profile of cashflows
available to service different levels of debt. Therefore, in the capital
markets, users often want to isolate operating analysis and deal with
capital structure issues separately.
To illustrate this idea further, let us consider the two UK-based
supermarkets Tesco plc and Sainsbury’s plc. Figure 6.1 shows the income
statements of the two companies from 2021.

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Tesco plc Sainsbury’s

plc
Continuing operations
Revenue 61,344 29,895
Cost of sales (56,750) (27,529)
Impairment reversal on financial assets 39
Gross profit/(loss) 4,633 2,366
Administrative expenses (2,073) (1,430)
Other income 220
Operating profit/(loss) 2,560 1,156
Share of post-tax profits of joint ventures and associates 15
Finance income 9 20
Finance costs (551) (322)
Profit/(loss) before tax 2,033 854
Taxation (510) (177)
Profit/(loss) for the year from continuing 1,523
operations
Discontinued operations
Profit/(loss) for the year from discontinued operations (40)
Profit/(loss) for the year 1,483 677
Figure 6.1: Financial statements of Tesco plc and Sainsburys plc.
(Source: data from Tesco plc and Sainsbury’s plc 2022 annual reports)
We can see that, although these companies would both be considered as
‘grocery stores’, they generate earnings in slightly different ways.
Sainsbury’s plc generates £220m of ‘other income’, which represents
25.8% of the pre-tax profit. Tesco does not have an equivalent line. On the
other hand, Tesco plc generates £15m of earnings from investments and
also generates £39m of earnings due to a reversal of an impairment on
financial assets.
It is also clear that the two companies’ earnings are impacted differently
by their financing. Sainsbury’s finance costs make up 1.1% of their overall
pre-tax costs while Tesco’s finance cost is only 0.9% of their overall pre-tax
costs.
If an analyst wished to understand which ‘grocery store’ is performing
better, it might be useful for them to look only at the performance of each
company’s operations and related net assets. In other words, an analyst
who focuses on a specific sector (in this case food retail) would be most
interested in the ‘food retail’ performance of both companies. This is not
to say they will ignore other items – such as interest (which is financing
rather than operating) or impairments; rather, they will deal with those
separately from their core focus on the food retailing business.
To do this, they must take the financial statements and remove the impact
of financial investments and borrowings to generate net operating profit
after tax. Be wary: this is not always simply the ‘operating profit’ taken
from the income statement (as can be seen by the fact that Tesco includes
a gain on reversing a financial asset impairment above the gross profit
line) – see Figure 6.2.

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AC3193 Accounting: markets and organisations

Profit or loss $XXX

Less:
Post-tax investment income $X × (1 – t)
Post-tax interest income $X × (1 – t)
Post-tax ‘one off’ incomes $X × (1 – t)
Add back:
Post-tax interest expense $X × (1 – t)
Post-tax ‘one off’ expenses $X × (1 – t)
Net Operating Profit After Tax (NOPAT) $XXX
Figure 6.2: Calculating net operating profit after tax.
The analyst should also analyse the balance sheet and only take into
account assets which are used in core operations and liabilities created
because of those operations. Financial assets, financial liabilities,
investments and even ‘excess cash’ should be excluded as they are not
required for the core operations of a business (see Figure 6.3).
Note: Excess cash is deemed to be cash which is over and above the ‘normal’
amount needed to fund operations. This may be difficult to know with
precision; however an analysis of similar companies’ cash balance to sales
ratio may indicate if a company holds more cash than required.

Net Operating Working Capital

Current Assets $XXX
Excluding: Excess Cash
Less:
Current Liabilities ($XXX)
Excluding: Current debt
PLUS
Net Non-Current Operating Assets
Non-current operating assets $XXX
Less:
Non-interest bearing Non-Current liabilities ($XXX)
Net Operating Assets $XXX
Figure 6.3: Calculating net operating assets.
Knowing these two figures allows an analyst to calculate Return on Net
Operating Assets (RNOA) rather than just ROE. This gives a greater level
of insight into a company’s operational performance.

Worked example 6.3

The following data has been extracted from the Sainsbury’s plc and Tesco
plc financial statement. The operating profit has been taken and adjusted
accordingly to present a Net Operating Profit after Tax (Figure 6.4).

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 Chapter 6: Key accounting ratios and measures for the capital markets

Tesco plc Sainsbury’s plc

Profit/(loss) for the year 1,483 677
Less:
Post tax investment income (40) -
Post tax finance income (7) (16)
Add back:
Post tax finance expense 413 255
One off loss on discontinued operations 40
(Note: This loss is presented post tax in the SPL)
Net operating profit after tax 1,889 916

Figure 6.4: Calculation of NOPAT for Tesco plc and Sainsburys plc.

This has assumed the ‘other income’ within the Sainsbury’s accounts is still
operational by nature.

Note: To achieve the same figure more quickly, you can start with the Operating
Profit (which is pre-tax), adjust for anything which is needed appearing above this
line, and then multiply the result by (1 – effective tax rate). For Tesco:

( ï ) × (ï)  

The Net Operating Assets can then be obtained by extracting the appropriate
figures from the balance sheet. Note how this differs from the traditional ‘net asset’
figure (see Figure 6.5).

Operating working capital Tesco plc Sainsbury’s plc

Inventories 2,339 1,797
Trade and other receivables 1,263 683
Current tax assets 93
Cash and cash equivalents 2,345 825
Less:
Trade and other payables (9,181) (4,546)
Current tax liabilities (11) (169)
Provisions (283) (100)
(3,435) (1,510)
Net non-current operating assets
Goodwill and other intangible assets 5,360 1,006
Property, plant and equipment 17,060 8,402
Right of use assets 5,720 5,560
Trade and other receivables 159 65
Deferred tax assets 85
Less:
Trade and other payables (53) (24)
Deferred tax liabilities (910) (806)
Provisions (183) (171)
27,238 14,032
Net operating assets 23,803 12,522
vs
Net assets 15,644 8,423
Figure 6.5: Net Operating Assets and Net assets for Tesco plc and Sainsbury’s plc.

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AC3193 Accounting: markets and organisations

We can then see how the traditional ROE differs from the RNOA (Figure 6.6).

Tesco plc Sainsbury’s plc

ROE 9.5% 8.0%
RNOA 7.9% 7.3%
Figure 6.6: ROE and RNOA for Tesco plc and Sainsbury’s plc.

These calculations reveal something of interest. We can see that Tesco plc
is generating a higher ROE than Sainsbury’s plc. However, in terms of their
core operations, the return generated is much more similar. As such, we may
conclude that these two companies are operationally comparable, even if
Tesco plc generates further return from its financing/investing activities.

Activity 6.2
Study Table 5.3 from Chapter 5 of Palepu et al. (2022). Then answer the following
questions.
1. How does the ROE of H&M compare to that of Inditex and other peers?
2. Compare and contrast the RNOA of the different companies. What conclusions can
you draw from this about the performance of each company as a fashion retailer?

6.4 The need for standardised data

As discussed above, a single financial ratio calculated alone means very
little. To gain insights, we need to compare these metrics over time, from
company to company, or from industry to industry. This does, however,
create problems.
Not all financial statements follow the exact same format. For example, the
statements of companies that follow accounting standards under USGAAP
will look different to those produced following IFRS. As such, it may be
difficult to compare the ratios described above.
In addition, companies may have one-off balances and transactions which
need to be excluded or presented in isolation so we can see what the
figures look like without these non-recurring events. If such adjustments
are not made, ratio movements may look unusual; ratio analysis could
suggest that a company’s performance and position have moved – either
favourably or adversely – even though the opposite is actually the case.
To attempt to solve this problem, it is useful to ‘standardise’ the financial
statements before calculating financial ratios.
Simply put, this involves rewriting the financial statements into an
order which suits the party performing the analysis, and categorising
transactions and balances into simpler categories. There is no one way of
doing this; the approach an analyst takes will depend on the companies
they are looking at and the particular aims of their analysis.

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Worked example 6.4

Best Buy Co. Inc is a consumer retailer of electronics with more than 1,000
stores across the USA and Canada. The company follows USGAAP. Harvey
Norman Holdings Ltd is a large national retailer of electrical products (and home
furnishings), based in Australia but with stores globally. The company prepares
accounts following Australian Accounting Standards and local legislation.

The unadjusted income statements, as prepared under their respective

jurisdictions, are shown in Figures 6.7 and 6.8.

Fiscal year ended January 30, 2021

Revenue $ 47,262
Cost of sales 36,689
Gross profit 10,573
Selling, general and administrative expenses 7,928
Restructuring charges 254
Operating income 2,391
Other income (expense):
Gain on sale of investments 1
Investment income and other 37
Interest expense (52)
Earnings before income tax expense 2,377
Income tax expense 579
Net earnings $ 1,798
Figure 6.7: Unadjusted income statement for Best Buy Co. Inc.

(Source: Data from https://www.sec.gov/Archives/edgar/

data/764478/000076447821000024/bby-20210130x10k.htm)

June 2021
$000
Note
Sales of products to customers 3 2,768,328
Cost of sales (1,838,365)
Gross profit 929,963

Revenues received from franchisees 3 1,345,782

Revenues and other income items 3 324,521
Distribution expenses (49,971)
Marketing expenses (377,639)
Occupancy expenses 3,13,15 (243,066)
Administrative expenses 4 (637,583)
Other expenses (67,585)
Finance costs 4,19 (50,213)
Share of net profit of joint venture entities 27 8,320
Profit before income tax 1,182,529
Income tax expense 5 (335,684)
Profit after tax 846,845
Figure 6.8: Unadjusted income statement for Harvey Norman Holdings Ltd.

(Source: Data from http://clients.weblink.com.au/news/pdf/02415189.pdf)

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It can be seen that, although the data is similar, it is presented slightly differently.
This makes it difficult to calculate ratios or to compare performance or financial
stability. The statements can be standardised in the following way.

• Consider the proforma for a standard/normal income statement.

• Classify each item in the unadjusted income statements so that it ‘best fits’
into a logical part of the standard proforma. (Ensure you are consistent from
company to company.)

• Calculate the subtotal of each proforma line item and re-prepare the income
statement using this new format.

By following these steps, an analyst will produce a statement similar to that in

Figure 6.9.

Best Buy Co. Inc HNH Ltd

2021 2021
Revenue 47,262 2,768
Cost of sales (36,689) (1,838)
Gross profit 10,573 930
Selling, general and admin expenses (7,928) (1,308)
Net other operating income/expense (254) 1,603
Operating income 2,391 1,225
Net non-operating income/expense 38 8
Net interest expense (52) (50)
Pre-tax income 2,377 1,183
Tax expense (579) (336)
Net earnings 1,798 847
Figure 6.9 Standardised income statements for Best Buy Co. Inc and Harvey
Norman Holdings Ltd.

This will allow the analyst to generate ratios such as profit margins and interest
cover for the two companies on a like-for-like basis.

Activity 6.3
Obtain the financial statements of Apple Inc and Samsung Electronics Co Ltd from the
investor section of their websites. Attempt to standardise the income statements so that
they are in the same format.
Note: Cengage (the publisher of the core text Palepu et al. (2022) has some material
available online that may help you to produce standardised accounts using Excel
functionality. This would make the process quicker if you were required to standardise
multiple accounts over multiple years.
Visit www.cengage.uk/ to find out more.

6.5 Capital market metrics

The above ratios can all be used by analysts to ensure they understand
the financial performance and position of a company from its financial
statements. Those involved in making investments and offering advice will
need to go further, exploring investment ratios such as dividend yield and
earnings per share. The key investor ratios are outlined below.

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Earnings per share (EPS): This is a key metric which allows investors to see the
magnitude of return they obtain for each individual share
earnings
they own.
number of ordinary shares
Care must be taken when looking at the number of
shares in issue in case a historic bonus issue could skew
the data.
USGAAP and IFRS require listed entities to calculate and
present this value on the face of the income statement.
Earnings yield: This allows investors to see the proportional return a
company is generating compared with the value tied up
EPS
within the share.
share price
Although a company may have a growing EPS, if the
share price is outgrowing this, then the yield will be
dropping.
This relative measure may therefore be more insightful
and a better metric to compare from company to
company.
Dividend yield: Although earnings yield can give a good indication of a
company’s ability to generate a return, it does not reveal
dividend per share
the cash return that an investor is likely to obtain since
share price
companies may choose not to pay out 100% of the
earnings figure.
The dividend yield is therefore a better metric as
investors can see how much they are likely to obtain in
cash terms from having an investment in a company.
PE ratio (P/E ratio) This ratio is the inverse of the earnings yield. It gives an
indication of how much investors are willing to pay for
share price
$1 of current earnings.
earning per share
For example, a PE ratio of 9 suggests investors are willing
to pay $9 today for $1 of current earnings.
This is an indicator that investors see potential in future
earnings. The higher the metric, the more the markets
must believe the company’s future holds good prospects.

Activity 6.4
Using either Google finance (Google.com/finance) or Yahoo Finance (finance.yahoo.com),
search for a number of companies who operate in the same industry. Can you see that
the metrics above have been calculated and presented for you?
Which metrics are missing, so you would need to calculate them for yourself?

6.6 Non-GAAP metrics

Within Chapter 2, we explored the need for regulated accounting
standards. Capital market participants require comparable data from
one company to another as this is crucial for understanding. Without
consistency, it would be difficult to trust financial information.
In recent years however, some company management teams have
recognised that these standards do not always allow them to capture the
unique nature of their individual company. As a result, many companies
choose to offer guidance on their performance using different metrics –
non-GAAP metrics.

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Some of the largest companies listed on US stock exchanges use non-GAAP

metrics to discuss performance. For example:
• Walmart Inc. reports Return on Investment (ROI) and Return on
Assets (ROA) within its SEC filings.
• Amazon.com Inc reports what it deems to be its ‘free cash flows’.
• CVS Health Corporation reports an adjusted operating income and
adjusted EPS.
• United Health Group Incorporated reports an adjusted
operating income and adjusted EPS, but only in its quarterly earnings
release (not within the SEC filings).
• Exxon Mobil Corporation reports an adjusted earnings figure.
• Berkshire Hathaway Inc reports and comments on the ‘gain in
float’ (a term it defines).
• Alphabet Inc reports a ‘constant currency’ revenue figure and the
growth of this metric.
It is interesting to see, however, that Apple Inc chooses not to make any
additional non-GAAP metrics available.

Activity 6.5
Research a selection of the above companies’ SEC filings (10-Ks and 10-Qs), available on
their Investor Relations webpages or via the ‘SEC Edgar search and access’ function.
Find the discussion behind these metrics; read why management have chosen to disclose
these metrics and why they are considered important.
Assess the possible dangers of relying on these metrics for third parties such as analysts
or shareholders.

6.7 Overview of chapter

This chapter has covered numerical analysis that analysts could perform
on company financial statements in order to obtain insights into how
the company is performing. Particular attention has been paid to the fact
that comparison – to other companies, to historical performance or to
expectations – is crucial to such analysis.
The chapter has further highlighted the need to break down the overall
analysis into constituent parts, so that an analyst can see the company’s
successes and failures in a granular way. This includes decomposing
‘return’ metrics as well as attempting to see overall performance compared
to performance of the core operations of a company.
The chapter concludes with a review of common metrics used in the
capital markets to consider whether companies are offering the markets an
appropriate level of return.

6.8 Reminder of learning outcomes

Having completed this chapter, and the Essential reading and activities,
you should be able to:
• explain key metrics which are used to analyse company performance
and the importance of analysing operations
• calculate key metrics from company to company which will allow for
comparison of performance
• analyse how a company’s strategy and market position are reflected
within the financial metrics.
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 Chapter 6: Key accounting ratios and measures for the capital markets

6.9 Test your knowledge and understanding

Luke & Laing (L&L) and LAZD are two publicly listed home furnishing retail
stores in the UK. L&L has smaller operations and is located only in affluent
areas based in the South East of England. Its stores are only located on busy
high streets. LAZD on the other hand operates nationally, with much larger
stores in out of town retail areas.
The following information is taken from the companies’ 2022 financial
statements.
Luke & Laing LAZD
£000s £000s
Revenue 2,000 32,000
Cost of sales 920 26,500
Gross profit 1,080 5,500

Cash and cash

equivalents 90 1,400
Trade receivables 50 300
Inventory 340 540
Other current assets 30 320
Trade payables 70 1,900
Other current liabilities 20 300

PP&E 1,130 22,400

Intangible assets 640 12,700
Based on the reported information above, which company is more efficient
at utilising its resources?

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