1. RATIO ANALYSIS
JW S4 Int2 BM

2. Ratio Analysis
The Trading Profit and Loss and the Balance Sheet can be analysed to highlight an organisation’s:
Profitability – to show whether the organisation is earning more that it is paying out
Efficiency – is the organisation making the best use of its resources?
Liquidity – does the organisation have enough money to pay its bills?
JW S4 Int2 BM

3. Ratio Analysis – Why use Ratios?
Ratio analysis is used to:
Compare current performance with that of previous years
Compare performance with that of similar organisations
Identify differences in performance to help decide on future action
Highlight trends over a period of time
To assist with decision making
JW S4 Int2 BM

4. Ratio Analysis Gross Profit Percentage Net Profit Percentage
Profitability Ratios
Gross Profit Percentage
Net Profit Percentage
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5. Gross Profit Percentage
Profitability Ratio
Gross Profit Percentage
Gross Profit x 100
Net Sales
Measures the profit
made from buying and
selling stock.
If the GPP needs to be improved, a business may:
Increase its selling price
Find cheaper suppliers
Try to negotiate discounts from suppliers
Increase supervision to reduce theft or breakages of stock
JW S4 Int2 BM

6. GROSS PROFIT PERCENTAGE
Profitability Ratios
GROSS PROFIT PERCENTAGE
A decrease in GP% ratio might indicate:
the price of goods bought has gone up
goods have been stolen
There is wastage in the production process
An increase in GP% ratio might indicate:
The selling price has gone up
the cost of materials has decrease
a cheaper supplier has been found
There is improved efficiency in the production process
Improvements:
either cut the costs of production, or
increase the selling price to customers
JW S4 Int2 BM

7. Net Profit Percentage Net Profit x 100 Sales
Profitability Ratio
Net Profit Percentage
Net Profit x 100
Sales
Measures the profit made after the business has paid all business expenses.
Ways to improved the NPP:
Identify any expenses that can be reduced
Try to improve their gross profit percentage
JW S4 Int2 BM

8. Ratio Analysis Liquidity Ratios Current Ratio/Working Capital Ratio
Acid Test Ratio
JW S4 Int2 BM

9. Current Ratio/ Working Capital Ratio
Liquidity Ratio
Current Ratio/ Working Capital Ratio
Current Assets
Current Liabilities
Shows the ability of a
business to pay its
short-term debts.
An answer of 2:1 is
regarded as generally
acceptable.
To improve the WCR:
try to increase current assets, particularly cash
seek ways to decrease current liabilities.
However, The WCR can be
too high.
A high bank figure may mean that funds could be better employed in the business to generate income rather than sitting in the bank.
JW S4 Int2 BM

10. Acid Test Ratio Liquidity Ratio Current Assets –Stock
Current Liabilities
Shows the ability of a business to pay its short-term debts in a crisis situation.
An answer of 1:1 is regarded as generally acceptable
Stocks are removed from current assets as it cannot be guaranteed that they can be quickly sold to generate cash to pay off debts.
too high = too much money tied up in liquid assets (cash in the bank could be put to better use)
Too low = cash flow problem exists – will not be able to pay short term bills
JW S4 Int2 BM

11. Ratio Analysis Efficiency Ratios Return on Capital Employed
Stock Turnover
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12. Return on Capital Employed
Efficiency Ratio
Return on Capital Employed
Net Profit x
Capital Employed
Measures the return on the capital invested in the business by the owner or shareholder.
The owner or shareholder should compare the Return on Capital Employed with the return offered by other investment opportunities
JW S4 Int2 BM

13. RATE OF STOCK TURNOVER The RoST measures efficiency
RATE OF STOCK TURNOVER = Cost of Goods Sold
Average Stock
this measures the number of times during the year a business sells its stock.
There is no ideal figure:
A greengrocer will buy and sell daily or weekly whilst a furniture shop will buy and sell 3-4 times per year
However, a a general rule businesses want to
turnover stock quickly!
JW S4 Int2 BM

14. If stock turnover is reducing this may indicate:
Efficiency Ratios
Rate of Stock Turnover
If stock turnover is reducing this may indicate:
Higher stock levels, eg
slow moving stock
obsolete stock.(out of date – no longer able to sell)
May need to tighten up control over purchasing
JW S4 Int2 BM

15. Ratio Analysis – Why use Ratios?
Ratio analysis is used to:
Compare current performance with that of previous years
Compare performance with that of similar organisations
Identify differences in performance to help decide on future action
Highlight trends over a period of time
To assist with decision making
JW S4 Int2 BM

16. Limitations of Ratio Analysis
Information contained in annual accounts is historical as it relates to last year’s trading.
Inter-firm comparisons must be made with firms of similar size and in the same type of industry.
JW S4 Int2 BM

17. Limitations of Ratio Analysis
Findings may not take into account external (PESTEC) factors such as recession, inflation or exchange rates
Findings do not show the implications of product developments or declining products
Findings do not reveal internal problems such as staff morale or staff turnover
JW S4 Int2 BM