RATIO ANALYSIS JW S4 Int2 BM. Ratio Analysis The Trading Profit and Loss and the Balance Sheet can...

RATIO ANALYSISRATIO ANALYSIS

JW S4 Int2 BMJW S4 Int2 BM


Ratio AnalysisRatio Analysis

The Trading Profit and Loss and the The Trading Profit and Loss and the Balance Sheet can be analysed to Balance Sheet can be analysed to highlight an organisation’s:highlight an organisation’s:

ProfitabilityProfitability – to show whether the – to show whether the organisation is earning more that it is organisation is earning more that it is paying out paying out

EfficiencyEfficiency – is the organisation – is the organisation making the best use of its resources?making the best use of its resources?

LiquidityLiquidity – does the organisation – does the organisation have enough money to pay its bills?have enough money to pay its bills?


Ratio Analysis – Why use Ratio Analysis – Why use Ratios?Ratios? Ratio analysis is used to:Ratio analysis is used to:

Compare current performance with that of Compare current performance with that of previous yearsprevious years

Compare performance with that of similar Compare performance with that of similar organisationsorganisations

Identify differences in performance to help Identify differences in performance to help decide on future actiondecide on future action

Highlight trends over a period of timeHighlight trends over a period of time

To assist with decision makingTo assist with decision making



Profitability RatiosProfitability Ratios

Gross Profit PercentageGross Profit Percentage Net Profit PercentageNet Profit Percentage


Gross Profit PercentageGross Profit Percentage

Gross ProfitGross Profit x 100 x 100

Net SalesNet Sales

Measures the profitMeasures the profit

made from buying andmade from buying and

selling stockselling stock..

If the GPP needs to be If the GPP needs to be improved, a business improved, a business may:may:

Increase its selling Increase its selling priceprice

Find cheaper suppliersFind cheaper suppliers

Try to negotiate Try to negotiate discounts from discounts from supplierssuppliers

Increase supervision Increase supervision to reduce theft or to reduce theft or breakages of stockbreakages of stock

Profitability Ratio


A decrease in GP% ratio might indicate:•the price of goods bought has gone up• goods have been stolen•There is wastage in the production process

An increase in GP% ratio might indicate:•The selling price has gone up• the cost of materials has decrease • a cheaper supplier has been found•There is improved efficiency in the production process

Improvements:•either cut the costs of production, or •increase the selling price to customers

Profitability Ratios

GROSS PROFIT PERCENTAGE


Net Profit PercentageNet Profit Percentage

Net Profit Net Profit x 100 x 100SalesSales

Measures the Measures the profit made after profit made after the business has the business has paid all business paid all business expenses.expenses.

Ways to improved Ways to improved the NPP:the NPP:

Identify any Identify any expenses that expenses that can be reducedcan be reduced

Try to improve Try to improve their gross profit their gross profit percentagepercentage

Profitability Ratio



Liquidity RatiosLiquidity Ratios

Current Ratio/Working Capital Current Ratio/Working Capital RatioRatio

Acid Test RatioAcid Test Ratio


Current Ratio/Current Ratio/Working Capital RatioWorking Capital Ratio

Current Assets Current Assets Current Liabilities Current Liabilities

Shows the ability of aShows the ability of abusiness to pay itsbusiness to pay itsshort-term debts. short-term debts.

An answer of 2:1 isAn answer of 2:1 isregarded as generallyregarded as generallyacceptable.acceptable.

To improve the WCR: To improve the WCR: try to increase current try to increase current

assets, particularly assets, particularly cashcash

seek ways to decrease seek ways to decrease current liabilities.current liabilities.

However, The WCR can beHowever, The WCR can betootoo high. high.

A high bank figure may A high bank figure may mean that funds could mean that funds could be better employed in be better employed in the business to the business to generate income rather generate income rather than sitting in the than sitting in the bank. bank.

Liquidity Ratio


Acid Test RatioAcid Test Ratio

Current Assets –Stock Current Assets –Stock

Current LiabilitiesCurrent Liabilities

Shows the ability of a Shows the ability of a business to pay its business to pay its short-term debts in a short-term debts in a crisis situation. crisis situation.

An answer of 1:1 is An answer of 1:1 is regarded as generally regarded as generally acceptableacceptable

Stocks are removed Stocks are removed from current assets as from current assets as it cannot be it cannot be guaranteed that they guaranteed that they can be quickly sold to can be quickly sold to generate cash to pay generate cash to pay off debts.off debts.

too high = too much money tied up in liquid assets (cash in the bank could be put to better use)

Too low = cash flow problem exists – will not be able to pay short term bills

Liquidity Ratio



Efficiency RatiosEfficiency Ratios

Return on Capital EmployedReturn on Capital Employed

Stock TurnoverStock Turnover


Return on Capital Return on Capital EmployedEmployedNet ProfitNet Profit x 100 x 100Capital EmployedCapital Employed

Measures the Measures the return on the return on the capital invested capital invested in the business by in the business by the owner or the owner or shareholdershareholder..

The owner or The owner or shareholder shareholder should compare should compare the Return on the Return on Capital Capital Employed with Employed with the return the return offered by other offered by other investment investment opportunities opportunities

Efficiency Ratio


RATE OF STOCK TURNOVERRATE OF STOCK TURNOVER

RATE OF STOCK TURNOVER = Cost of Goods Sold Average Stock

this measures the number of times during the year a business sells its stock.

There is no ideal figure:

A greengrocer will buy and sell daily or weekly whilst a furniture shop will buy and sell 3-4 times per year

However, a a general rule businesses want to turnover stock quickly!

The RoST measures efficiency


If stock turnover is reducing this may indicate:

• Higher stock levels, eg • slow moving stock• obsolete stock.(out of date – no longer able to sell)

• May need to tighten up control over purchasing

Efficiency Ratios

Rate of Stock Turnover


Ratio Analysis – Why use Ratio Analysis – Why use Ratios?Ratios? Ratio analysis is used to:Ratio analysis is used to:

Compare current performance with that of Compare current performance with that of previous yearsprevious years

Compare performance with that of similar Compare performance with that of similar organisationsorganisations

Identify differences in performance to help Identify differences in performance to help decide on future actiondecide on future action

Highlight trends over a period of timeHighlight trends over a period of time

To assist with decision makingTo assist with decision making


Limitations of Ratio Limitations of Ratio AnalysisAnalysis

Information contained in Information contained in annual accounts is annual accounts is historicalhistorical as it relates to last year’s as it relates to last year’s trading.trading.

Inter-firm comparisons must Inter-firm comparisons must be made with firms of be made with firms of similar size and in the similar size and in the same type of industry.same type of industry.


Limitations of Ratio Limitations of Ratio AnalysisAnalysis Findings may not take into account Findings may not take into account

external (PESTEC) factors such as external (PESTEC) factors such as recession, inflation or exchange recession, inflation or exchange ratesrates

Findings do not show the Findings do not show the implications of product implications of product developments or declining productsdevelopments or declining products

Findings do not reveal internal Findings do not reveal internal problems such as staff morale or problems such as staff morale or staff turnoverstaff turnover

RATIO ANALYSIS JW S4 Int2 BM. Ratio Analysis The Trading Profit and Loss and the Balance Sheet can...

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