1. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.1 Chapter 34 Introduction to accounting ratios

2. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.2 Learning objectives After you have studied this chapter, you should be able to:  Calculate some basic accounting ratios  Use accounting ratios to calculate missing figures in financial statements  Offer some explanations for changes in these ratios over time

3. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.3 The need for accounting ratios Accounting ratios are used to enable us to analyse and interpret accounting statements.

4. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.4 Mark-up and margin  Mark-up is the fraction or percentage of cost price that is gross profit, and is calculated as gross profit divided by cost price.  Margin is the fraction or percentage of the selling price that is gross profit, and is calculated as gross profit divided by selling price.

5. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.5 Activity The following figures are recorded for 2008: Opening inventory £400 Closing inventory £600 Purchases £5,200 A uniform mark-up rate of 20% is applied Calculate the gross profit and sales figures

6. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.6 Activity (Continued)

7. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.7 Activity (Continued) To calculate mark-up £5,000 + 20% = sales of £6,000

8. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.8 Activity (Continued)

9. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.9 Activity (Continued) A business records the following figures for 2009: Opening inventory £500 Closing inventory £800 Sales£6,400 A uniform margin rate of 25% is in use Find the gross profit and purchases figures

10. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.10 Activity (Continued)

11. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.11 Activity (Continued) To calculate margin £6,400 – 25% = £4,800

12. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.12 Activity (Continued)

13. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.13 Manager’s commission  Managers often receive a basic salary plus a percentage of the profits.  A manager’s commission can be calculated as:

14. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.14 Gross profit as a percentage of sales  The ratio represents the amount of gross profit for every £100 of sales revenue.  It is used as a test of the profitability of sales.  Gross profit as a percentage of sales is calculated as:

15. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.15 Inventory turnover  The quicker we sell our inventory, the more profit we make.  To check how quickly we are turning over our inventory, we use the formula:

16. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.16 Current ratio  This ratio indicates whether there are sufficient relatively liquid assets to meet short-term debts when due.  The ratio is calculated as: Current assets divided by current liabilities

17. Frank Wood and Alan Sangster, Frank Wood’s Business Accounting 1, 12 th Edition, © Pearson Education Limited 2012 Slide 34.17 Learning outcomes You should have now learnt: 1. That accounting ratios can be used to deduce missing figures, given certain assumptions 2. That if the mark-up is known, the margin can easily be calculated 3. That if the margin is known, the mark-up can easily be calculated 4. How to calculate the gross profit on sales and inventory turnover ratios 5. What may cause these ratios to change over time