Ratios

Question 1

1. Percentage of gross profit on turnover ratio
2. What to do if the ratio decreases
3. Why the ratio will increase

Answer 1

1. Gross profit/ sales X 100
2. • Make sure there are no errors in recording or errors in the sales and the cost of sales calculations
     - Make sure there is no stock losses (fire, theft, obsolete, etc.)
     - make sure that not too many trade discounts are given to customers
3. • Gave less trade discounts
     - Having less promotions

Question 2

1. Percentage gross profit on cost of sales ratio
2. What this ratio does
3. If the ratio is lower than the target mark up then:
4. If the ratio is higher than the target mark up then:

Answer 2

1. Gross profit/ cost of sales x 100
2. This ratio tests if the business meets the profit mark up. You need to compare your answer to the target mark up
3. Too many trade discounts/ promotions or stock losses
4. Could only be due to errors:
   - incorrect cost of sales calculations
   - stock purchased not being recorded correctly
   - sales not being recorded correctly

Question 3

1. Percentage operating expenses on turnover ratio
2. What to always remember about turnover?
3. What does this ratio tell you?
4. Why would it be a good thing if the percentage decreased from last year?
5. What to do if the percentage increases?

Answer 3

1. Operating expenses/ sales x 100
2. Remember to subtract debtors allowances amount from sales
3. This ratio tells you the percentage of sales that is spend on operating expenses
4. Because it could be that:
   - the business has controlled its expenses better
   - the business’ sales have increased more than their expenses
5. If the percentage is too high the business needs to find a way to cut costs and expenses

Question 4

1. Percentage operating profit on turnover ratio
2. What does this ratio test?
3. What can it be compared to?

Answer 4

1. Operating profit/sales x 100
2. The ratio tests the businesses control over operating expenses
3. It can be compared to percentage gross profit on cost of sales, if this percentage is much lower than the percentage gross profit on cost of sales ratio then it means the businesses expenses were not controlled well

Question 5

1. Percentage net profit on turnover ratio

2. Why would it increase

Answer 5

1. Net profit/ sales x 100
2. if the % improves from one year to another it’s a good thing and means
   - the business cut its expenses and has better control. Should continue monitoring expenses to increase profitability
   - the sales have increased more than the business expenses

Question 6

Return on owners equity

2. What must you always make reference to in your answer
3. What to di when it decreases
4. What does thus ratio tell us

Answer 6

1. Net profit/ average owners equity x 100
2. Average owners equity is last year + this year divided by 2
3. Make reference to bank interest rates in answer
4. If it decreases from one year to the next: 1. Increase profitability by increasing sales through promotions. 2. Decrease expenses by keeping stricter control
5. The ratio tells us what return the owner is receiving based on the capital they invested

Question 7

Solvency

Answer 7

1. Total assets : total liabilities
2. The higher the total assets the better the business can cover its liabilities
3. If the ratio improves it means better financial position

Question 8

Current ratio

2. What does current assets consist of
3. What does current liabilities consist of
4. What it means if there is more assets
5. If it decreases:
6. What can it be compared to

Answer 8

1. Current assets : current liabilities
2. Current assets = inventories, trade and other receivables and cash and cash equivalents
3. Current liabilities = trade and other payables
4. There should be more assets. This means business has sufficient assets to cover short term debts and is in a good liquidity position
5. If the ratio decreases:
   - encourage more cash sales
   - decrease trade and other receivables
   - convert less liquid assets to cash by: 1. Having less money tied up in inventory and order smaller quantities of stock. 2. Encourage debtors to pay sooner. 3. Arrange to pay creditors between 60-90 days so you can use money received from debtors.
6. Ratio should be compared to acid test to determine amount of inventory

Question 9

Acid test ratio

Answer 9

1. Current assets - inventory : current liabilities
2. If it decreases the business may struggle to meet short term commitments
3. If business has too much inventory it can lead to:
   - stock becoming obsolete, outdated or damaged
   - bigger premise and storage needed to keep stock (expensive)
   - too much stock is hard to monitor… leads to theft