1. LO. Define & provide examples of the 5 main financial ratios.
Ratio Analysis
LO. Define & provide examples of the 5 main financial ratios.

2. Ratios
Ratios are used to measure and compare performance and liquidity of a business.
Ratio analysis

3. Performance ratios Return on capital employed Operating profit
ROCE (%) =
Operating profit
Capital employed
X 100
Shows how successful the managers are at earning a profit from capital used in the business.

4. Calculations Return on Capital Employed =55% Analysis Operating profit
Fixed assets ฿
Land 10,000
Vehicle 5,000
Machines 1,000
Current Assets
Debtors 1,000
Cash 500
Stock 2,000
Current Liabilities
Creditors 600
Bank loan 800
Net-Current Assets
(Working capital)
Net assets
Financed by:
Profit / Loss 10,000
Share capital 8,100
Capital employed
Return on Capital Employed
ROCE (%) =
Operating profit
Capital employed
X 100
ROCE (%) =
10,000
18,100
X 100
2,100
=55%
Analysis
For every baht (฿) invested, the business makes 55% extra.
18,100
18,100

5. Performance ratios Gross profit margin Gross profit Sales turnover
X 100
Shows how much gross profit is made for every $ earned

6. Calculations =84% Analysis Sales turnover X 100 42,000 50,000 X 100฿
Sales turnover 50,000
Cost of Sales 8,000
Gross profit
Expenses
Rent 15,000
Utility bills 4,000
Wages 10,000
Net profit
Gross profit
margin (%) =
Sales turnover
X 100
42,000
Gross profit
margin (%) =
42,000
50,000
X 100
13,000
=84%
Analysis
For every baht (฿) make from sales, 84% is kept as gross profit

7. Performance ratios Net profit margin Net profit Sales turnover X 100
Shows how much Net profit is made for every $ earned

8. Calculations =6% Analysis Sales turnover X 100 5,000 80,000 X 100฿
Sales turnover 80,000
Cost of Sales 20,000
Gross profit
Expenses
Rent 35,000
Utility bills 10,000
Wages 10,000
Net profit
Net profit
margin (%) =
Sales turnover
X 100
60,000
Net profit
margin (%) =
5,000
80,000
X 100
5,000
=6%
Analysis
For every baht (฿) make from sales, 6% is kept as Net profit profit

9. Which ratio to use? =84% Analysis =6% Analysis Sales turnover X 100
Gross profit
margin (%) =
Sales turnover
X 100
Gross profit
margin (%) =
Net profit
Sales turnover
X 100
Gross profit
margin (%) =
42,000
50,000
X 100
Net profit
margin (%) =
5,000
80,000
X 100
=84%
Analysis
For every baht (฿) make from sales, 84% is kept as gross profit
=6%
Analysis
For every baht (฿) make from sales, 6% is kept as Net profit profit

10. Liquidity ratios Current Ratio Current assets Current liabilities
Shows haw many times a business can pay its short term debts with current assets.
A good current ratio would be between 1.5 : 1 – 2 : 1 A ratio less than 1 would mean that a business could not pay its short term debts, and could be forced to cease trading. (It has no working capital)

11. Calculations Liquidity ratio =2.5:1 Analysis Current assets
Fixed assets ฿
Land 10,000
Vehicle 5,000
Machines 1,000
Current Assets
Debtors 1,000
Cash 500
Stock 2,000
Current Liabilities
Creditors 600
Bank loan 800
Net-Current Assets
(Working capital)
Net assets
Financed by:
Profit / Loss 10,000
Share capital 8,100
Capital employed
Liquidity ratio
Current ratio =
Current assets
Current liabilities
Current ratio =
3,500
1,400
2,100
=2.5:1
Analysis
2.5:1 means the business can pay it’s short term debts two and a half times. It has high liquidity!
18,100
18,100

12. Liquidity ratios Acid test ratio OR Liquidity ratio
Current assets - stock
Current liabilities
Similar to current ratio, however without stock because the nature of some companies may mean it is difficult to sell stock quickly (their stock is not liquid) for example a estate agent / car sales.
A good acid test ratio is between 0.5 : 1 – 1 : 1

13. Calculations Liquidity ratio =1:1 Analysis Current assets - stock
Fixed assets ฿
Land 10,000
Vehicle 5,000
Machines 1,000
Current Assets
Debtors 1,000
Cash 500
Stock 50,000
Current Liabilities
Creditors 600
Bank loan 800
Net-Current Assets
(Working capital)
Net assets
Financed by:
Profit / Loss 10,000
Share capital 8,100
Capital employed
Liquidity ratio
Current ratio =
Current assets - stock
Current liabilities
Current ratio =
3,500
1,400
50,100
=1:1
Analysis
1:1 means the business can JUST pay it’s short term debts. It has virtually no Liquidity!
79,600
18,100

14. Revision Questions

15. What is meant by a financial budget? [2]
Think, Pair, Share...
Write your answer on your white board
A financial budget is a numerical/quantitative plan showing future financial targets (goals or
limits) for a specific time period. [2]

16. Calculate the net profit margin for BTX in 2009. [2]
Think, Pair, Share...
Write your answer on your white board
Profit margin is profit/sales %. [1]
250/1100 × 100 = 22.72% Answer = 22.72% [2]
22% – 23 % acceptable for [2]
Method alone or arithmetic error [1], correct number without % [1]
If figures for 2008 are used (correctly) then 1 method mark could be available.

17. Explain what the current ratio tells Manfred about BTX’s financial position. [4]
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Write your answer on your white board

18. Knowledge of current ratio can be shown by indicating what it is or how it is calculated [2]
An answer that simply says ‘shows current assets and current liabilities of a business’ [1]
Analysis of usefulness: analysis implies saying something about what the change means to
BTX using the data [2]
So an answer that says ‘the figure has changed from 1.2 to 0.7’ is merely a description not an analysis and therefore would not be given a mark.

19. Current ratio is a measure of the relationship between current assets and short-term debts. It is a liquidity test designed to show the ease by which a company can pay debts on demand. (How easily assets can be turned in to cash). A fall in the ratio shows a decline in liquidity and therefore is not seen as a good thing because it implies that not all short-term debts can be met quickly.
Knowledge of current ratio [2]
Analysis of usefulness [2]

20. Do you think that the management of BTX should be worried about the performance of the company in 2009? Justify your answer. [6]
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21. • net profit rise (25%) good
sales fall (8.3%) bad
• net profit rise (25%) good
• profit margin rise (16.6 % to 22.72%) good
• return on capital (ROCE) down (20% to 16.6%) bad
• current ratio down (below safe levels) bad
Identification of directional changes in relevant indicators of BTX’s success [2] (The sales have fallen by 8.3%, this suggests the management should be worried about the performance because…
Analysis of data [2] Interpretation of the information could be quantitative or qualitative (However, net profits have risen…)
Evaluative comment [2] This will involve a positive assertion supported by a justification comment based on the analysis.
Therefore I think they should be worried because… ROCE OR
I think they should not be worried because… PROFIT MARGIN