Types of Ratios
- Profitability Ratios
- Liquidity Ratios
- Capital Structure Ratios
3 reason why interested parties are interested in Ratio Analysis
- Banks
- Government
- Suppliers
- Banks - Who are being asked to lend money to finance the business.
- Government - E.G HM Revenue & Customs, that want to it is receiving the amount due for VAT and the tax payable on the profits of the business
- Suppliers - Who want to know if they are likely to be getting paid.
What do profitability Ratios do?
2 reasons
- Try to examine wheatear the business is making a profit
2. Relationship between sales revenue and profits
Gross Profit Margin
Equation
(Gross Profit / Sales Revenue) x 100
Gross Profit Mark Up
Equation
(Gross profit / Cost of Sales) x 100
Over Head/ Turn Over Margin
Equation
(Overhead / Sales Revenue) x 100
Net Profit Margin
Equation
(Net Profit Margin / Sales Revenue) x 100
Gross Profit Margin
- It’s a percentage
2. Should be similar from year-to-year for the same business
Gross Profit Mark Up
- Has to be a percentage
2. Should be similar from year-to-year for the same business
Overheads in relation to revenue
- Has to be a percentage
2. It should fall as revenue increases, this is because not all overheads are variable
Net profit margin / Profit in relation to Revenue
- Should be similar from year-to-year for the same business
2. Should increase from year-to-year
ROCE
- Calculation of return on Capital Employed
(Net profit / Capital Employed) x 100
Cash
For Profitbilty
It is the actual amount of money held in the bank or as cash
Profit
For Profitabilty
- It is calculated figure
- Shows surplus of income over expenses for the year
- It takes note of adjustments for accurate and prepayments and non-cash items
- Such as depreciation and provision for doubtful debts
Why do you need Net current assets
Liquidity
Needed by all business in order to finance day-to-day trading activities
Net current assist Ratio
Liquidity
Current assets : Current liabilities
Liquid Capital Ratio
Liquidity
(Current assets - Inventories) / (Current liabilities)
Rate of inventory turnover
- What is it
- Equation
- Number of days inventory held on average
2.
(Cost of sales) / (Average inventories)
Trade Receivables Days
Liquidity
- What is it
- How many days on average, a trade receivable takes to pay, for goods sold to them by the business
Trade payables Day
Equation
Liquidity
(Trade payables / Purchases) x 365 days
Gearing ration
Equation
Capital Structure
Debt x ( loan capital + preference shares) /
equity x (ordinary shares + reserves)
- Can also be expressed as a percentage
Users of Ratios
Banks Government Managers Customers Employees Investors Shareholders Creditors
