Ratio Analysis Interpretation of Financial Statements

Importance of Financial Ratios Ratios show important relationships between financial figures Compares business’ performance over several financial periods Compare the business’ performance with that of other businesses within the same industry.

Profitability Ratios Help to assess the profitability of the business by giving an indication of the level of return the owner is getting.  Gross profit margin  Mark-up on cost  Net profit margin  Rate of return on capital fo

Efficiency Ratio: Help assess efficiency in the use of business assets/resources.  Rate of stock turn or Rate of stock turnover  Percentage of expense to turnover

Liquidity Ratios: Indicate business’ ability to pay its debts and manage its working capital  Working capital ratio or current ratio  Current ratio  Quick ratio

Mark-up: gross profit as a % of cost of sales. In this case the profit made is $44 per $100 spent.

Gross profit margin: Gross profit as a % of sales

Net profit margin: Net profit as a % of sales

Percentage expenses to turnover

Rate of Stock turn Also known as Rate of stock turnover No. of times in a year the average stock can be sold off

Working capital Amount of capital uses to day-to-day running expenses of a business. Working Capital= Current Assets- Current Liabilities Working Capital Ratio also known as Current Ratio indicates the ability of the business pay its bills/ meet all its expenses as they fall due.

Calculations of Working capital ratio

Quick Ratio Also known as liquid ratio or acid test ratio.

owner’ Equity Also known as owner’ capital

Capita Employed( Net worth) It is the amount of money actually being used in the business, regardless to whom it belongs. Capital Employed= Owner’s Equity+ Long term Liabilities Example: xyz’s owners equity is $1,300,000 and long term liabilities(Long term Loan) is $20,000 Capital Employed= $1,30,0000+$20,000=$1,32,0000

Rate of return on capital It is the net profit as a percentage of capital at the beginning of the period.

Stock valuation Every business will carry out a physical stock-take ie. count the units of goods not sold. Physical stock-take is important to many businesses because close stock may be a main component current assets. Incorrect valuation will affect the true and fair value of the assets of the business. Incorrect valuation closing stock will affect cost of sales of the business, in turn affecting the gross profit and net profit current year as well as the subsequent year since the closing stock of the current year is taken as the opening stock of the following year.

Basis of stock valuation Cost or net realizable value whichever is LOWER. Cost =purchase price+ all the other expenses incurred in bringing the goods to the current location Net realizable value =amount received from the sale of stock after deducting all expenses that will be incurred in selling the goods. Example: If the cost price of the stock is $50000 and the net realizable value(current market price) is $45000, the sock will be valued at $ The concept of conservatism is considered in this case.