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Accounting Ratio’s

Accounting Ratio’s. We are learning to: Identify the reasons for using financial ratio’s. Explain and demonstrate how to use financial ratio’s . Reasons. Each ratio is looking at something specific with the business finances. Solvency – able to pay its expenses.

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Accounting Ratio’s

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  1. Accounting Ratio’s We are learning to: Identify the reasons for using financial ratio’s. Explain and demonstrate how to use financial ratio’s

  2. Reasons Each ratio is looking at something specific with the business finances. • Solvency – able to pay its expenses. • Profitability – is company making enough profit to • Performance – how quickly sold stock, how long it takes to collect debts and a business makes use of its assets.

  3. Solvency (Liquidity) Ratios(how much money is available to pay the bills) • How liquid is your business. • If does not have enough current assets to pay their liabilities when they become due. If can’t pay bills = insolvency Current Ratio= How many assets it has compared to liabilities Current Assets/Current Liabilities = (as a ratio) x:1 Ratio of between 1.5:1 and 2:1 is considered about right Over 2 is considered not good as money could be used elsewhere to improve the business. Acid Test Ratio= How can meet its liabilities without selling stock. CA-Stock/CL = ??:1 Ratio of 1:1 is ideal Gearing = Long Term Loans/Capital Employed x100 = ??% +50% = high gear (too much risk) -50% = low gear(not enough)

  4. Profitability Ratios(how much profit in relation to Turnover and Capital used in the business)Return on Capital Employed (ROCE) Investors want to know how much profit their capital investment is making for them.(Also applies to shareholders) Important indictor of how efficiently a business is being managed but mean little if not compared to previous year or their competitors ROCE = Net profit/capital employed inc. Shareholders Funds x 100 = ???%

  5. Profit margins • Gross Profit margin ratio tells us the profit a business makes on its cost of sales or cost of goods sold. Tells us how much GP per £1 of turnover our business is earning. Tells us how manages its purchases of stock. GP Margin = GP/Turnover x100= ??% • Net Profit margin ratio tells us the NP per £1 of turnover a business has earned. NP Margin= NP/Turnover x100 = ??%

  6. Determining Performance Stock Turnover – how quickly they have sold their stock. The faster the stock turnover the more likely the business is efficient. This is important if the goods are perishable. • As a percentage Stock Turnover (in a number of times) = Cost of Sales/Average Stock(number of times) Average Stock is calculated by Opening Stock+Closing Stock/2 • In days Stock Turnover= Average stock/Cost of sales x 365.

  7. Debtors collection period Debtors/Credit Sales x 365 = total number of days it takes debtors to pay • Asset Turnover Asset Turnover =Sales/Total Assets Sales/FA and Sales/CA

  8. Now have a go • A business has £1200 in stock and is owed £800 by debtors. It owes £400 to suppliers, £400 in tax and £100 in loan interest to the bank. Its turnover is £16,000 and net profit is £4000. • Work out: Current Ratio Net Profit margin Acid Test

  9. The answer!

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