Topic 29 - Ratios Flashcards
Purpose of Ratio Analysis
- Compare performance with previous years
- Compare performance with competitors
- Compare against industry averages
- Highlight areas of the business that need attention
- Highlight trends to aid future decision-making
Limitations of Ratio Analysis
- Historical information so not relevant to future or current position of the business
- Ratios do not take into account external factors
- Ratios do not take into account internal factors
- Ratios do not take into account product developments
- Difficult to find competitors of the exact type and size to make comparisons
Gross Profit Percentage
gross profit / sales revenue x 100
Measures the percentage of profit made from buying and selling.
Improve by:
- Increasing sales revenue
- Switch to a cheaper supplier
Profit for the Year Percentage
profit for the year / sales revenue x 100
Measure the percentage of profit made once expenses have been deducted.
Improve by:
- Reducing expenses
- Increasing sales revenue
Return on Equity Employed
profit for the year / equity x 100
Measures the percentage of investment that is returned to shareholders.
Improve by:
- Reducing expenses
- Increasing sales revenue
Current Ratio
current assets / current liabilities
Measures the business’s ability to pay back short-term debts.
Improve by:
- Securing more current assets
- Reducing current liabilities
Acid Test Ratio
(current assets - closing inventory) / current liabilities
Measures the business’s ability to pay back short-term debts in a crisis situation.
Improve by:
- Secure more current assets
- Implement JIT to avoid money being tied up in inventory
Rate of Inventory Turnover
cost of sales / average inventory
Measures the amount of time the business restocks its inventory in one year.
Improve by:
- Use JIT to avoid overstocking
- Sell off excess stock
- Negotiate sale or return with suppliers
