5. Performance Indicators - Ratios

Question 1

MARGINS on SALES:
1 of 2
Gross Profit Margin

Answer 1

Gross Profit / Sales rev

Question 2

MARGINS on SALES:
2 of 2
Net Profit Margin

Answer 2

Net Profit / Sales rev

Also known as:
Profit from Operations
Operating profit
Profit before interest and tax

Question 3

RETURNS on INVESTMENTS
1 of 2
Return on Capital Employed (ROCE)

Answer 3

Net Profit / TALCL * 100

Question 4

RETURNS on INVESTMENTS
2 of 2
Return on net assets (RONA)

Answer 4

Net profit / Net assets * 100

Also can get same result from:

Operating profit margin % * Asset turnover

Question 5

LIQUIDITY or ‘WORKING CAPITAL’ : non-period
1 of 2
Current Ratio

Answer 5

Current assets / Current liabilities

Examines whether value of liquid assets covers the value of short-term liabilities.

normally written as x : 1 but just a straight number in assessment.

Often said should be about 2:1 , however in certain types of biz its not expected to be so high. In a supermarket for example AR will be low compared to AP and inventories are not held for long periods.

2:1 Can be used as a guide for biz where inventory does not sell so quick and where AR is likely to be on credit as well as AP. …. but in a given case look for comparisons (other periods or other similar orgs) rather than judging a single fig against this guideline.

Remember a SFP is a snapshot … a single transaction could make considerable change.

Question 6

LIQUIDITY or ‘WORKING CAPITAL’ : non-period
2 of 2
Quick Ratio (Acid test)

Answer 6

(Current assets - inventory) / Current liabilities

As a guide a level of 1:1 but a biz with frequent cash inflows may operate atisfactorily on a lower quick ratio.

Comparison with similar businesses gives more useful info. Also remember SFP is a snapshot. In most cases timing of cashflows in and out will be vital factor.

Question 7

LIQUIDITY or ‘WORKING CAPITAL’ : period
1 of 5
Receivables collection period in days

Answer 7

Trade Receivables / Credit sales * 365

Question 8

LIQUIDITY or ‘WORKING CAPITAL’ : period
2 of 5
Inventory Holding Period in days

Answer 8

Closing Inventory / Cost of Sales * 365

May use average: (OI + CI) / 2

Could argue nether better.

Question 9

LIQUIDITY or ‘WORKING CAPITAL’ : period
3 of 5
Payables Payment Period in days

Answer 9

Trade Payables / Credit Purchases (or if unavailable CoS)

Question 10

FINANCIAL STRUCTURE RATIOS: GEARING
About long term financing of biz:
1 & 2
Gearing Ratio

Answer 10

Total Debt / Total Equity
D / E

Total Debt / (Total Debt + Total Equity)
D / D+E

NB working out Total Equity if given balance sheet ..include:
Shareholders funds
Share capital 
Reserves
Revaluation reserves

Question 11

Full Production Cost per unit

From Gareth Jones

Answer 11

Cost of Sales / Units produced

Nb full production cost is CofS … not including operations..
So if given Sales ; GP and Operating profit need to deduct GP from Sales not OP..

Question 12

Asset Turnover

Measures how well assets have been used this period to generate turnover

Answer 12

Sales rev / (Non-current assets + net current assets)

Ie. Sales rev / TALCL

Question 13

LIQUIDITY or ‘WORKING CAPITAL’ : period
4 of 5
Inventory turnover or ‘turns’
ie Number of times per year

Answer 13

CofS / Average Inventory
CofS / Closing inventory

This is just the reverse calc of Inventory Holding period and without the *365 to convert it to days.

A higher inventory turn indicates inventory is moving more quickly and this corresponds to a lower average of inventory. Speed should depend on type of business eg. perishable/non-perishable. Also remember seasons with for example fireworks, - SFP date may coinside with unusually high or low inventory ..

Question 14

LIQUIDITY or ‘WORKING CAPITAL’ :
5 of 5
Working Capital Cycle

Answer 14

Inventory Days + Receivable Days - Payable Days

A greater number of Working Capital Cycle Days indicates a greater investment in working capital (or working capital requirement)

Question 15

Interest Cover

How many times the business could pay it’s interest out of Profit from Operations

Answer 15

Profit from Operations / Finance Cost (ie Interest)

Question 16

£ Working Capital Required =

Answer 16

£ Inventory + £ Receivables - £ Payables

Question 17

CONTROL RATIO
1 of 3:
Efficiency ratio %
Idle time ratio %
Think of variance

Answer 17

standard hrs for actual production / actual hrs * 100
(don’t need to worry about rates)
Think also of the Activity ratio..

Idle hrs / Total hrs * 100

Question 18

CONTROL RATIO
2 of 3:
Activity Ratio (Output) %

Answer 18

Compare standard hours for actual production with the original plan for the period, the budgeted hours.
This is an indicator of how actual output compares with the budgeted output (known as Activity ratio)

Activity ratio:
standard hrs for actual production / budgeted hrs * 100

This can alternatively be expressed in terms of volume of output (The production volume ratio)

Production Volume Ratio:
Actual Output / Budgeted output

Question 19

CONTROL RATIO
3 of 3:
Capacity ratio

Answer 19

This control ratio compares the actual ‘capacity’ which has been used with the planned amount.

Capacity (here being measured in terms of direct labour hours) is the amount of available resources being used. Full capacity woud mean all possible resources were being used. Budgeted capacity (probably less than full capacity) would be set in line with planned levels of production and sales.

The capacity ratio shows what proportion of the planned resources have actually been used. This is particularly important when there are significant fixed costs which have been paid to make these resources available

Capacity Ratio:
Actual hrs worked / Budgeted hrs * 100

Question 20

Value added

A way of showing how the inputs to a company have been changed into valuable outputs (the sales)

Answer 20

‘Value added’ as a financial measure refers to the difference between the value of outputs and the value of inputs.

It shows the increase in monetary value which has resulted from the work done and the use of assets.

Value added = Sales - (Cost of Materials used + bought-in services)

OUTSIDE