RATIO ANALYSIS
We use ratios to effectively compare businesses.
The size of a business does not equate to the performance of a business.
PERFORMANCE RATIOS
Gross Profit Margin (%) --
Shows how much gross profit is made for every $ earned.
Gross Profit
x 100
Sales Turnover
Net Profit Margin (%) --
Shows how much net profit is made for every $ earned.
Net Profit
x 100
Sales Turnover
Return On Capital Employed (%)--(ROCE)
Shows how successful the managers are at earning a profit from capital used in the business.
Operating Profit
x 100
Capital employed
LIquidity RATIOS
Current Ratio --
Shows how many times the business can pay its short term debts with current assets.
A good current ratio would be between 1.5:1 - 2:1
A ratio less than 1 would mean that the business could not pay its short term debts, and could be forced to cease trading (It has no working capital)
Current Assets
Current Liabilities
Acid test Ratio OR
Liquidity Ratio --
Similar to current ratio, however WITHOUT the STOCK because the nature of some companies may mean it is difficult to sell stock quickly (thier stock is not liquid) eg, estate agent / car sales.
A good acid test ratio is between 0.5:1 - 1:1
Current Assets - Stock
Current Liabilities
EfficiencyRATIOS
Debtor's Collection Period Ratio --
The ratio assess how long it takes for the debtors to pay their accounts.
The answer will be shown in months. However if you are required to show formula in days, multiple by 365 instead.
The higher the ratio, the worse the business is at collecting debtors to pay on time.
Debtors
x 12
Sales
Creditor's Payment Period Ratio --
The ratio assess how long it takes for the business to pay their supplies.
The answer will be shown in months. However if you are required to show formula in days, multiple by 365 instead.
The higher the ratio could be good (keeping money in the business for longer, however not paying suppliers on time could advresly affect the bussiness's reputation.
The higher the ratio ; benefits the cash flow of business but paying late leads to : interest, don't get any credits or discounts.
Rate Of Stock Turnover Ratio --
The business wants to keep sufficient stock in the business, but holding too much could affect cash flow.
The ratio tells us how many times or days it takes sell all our stock.
Average Stock =
Opening + Closing
2
Creditors
x 12
Purchases
Times
COGS
Average stock
Days
Average Stock
x 365
COGS