Analysing year end accounts - ratios Flashcards
Operating ratio - Return on capital employed
Measures profitability
Calculates how much net profit is made from every £1 of capital invested
NET PROFIT/CAPITAL EMPLOYED x 100 = x%
eg 11,000 net profit, 200,000 capital
11,000/200,000 x 100 = 5.5%
So for every £100 invested, £5.50 profit is made
Operating ratio - Net profit percentage
Measure of efficiency
Calculates how much of our sales or income we convert into profit
If a business is operating efficiently, it will be minimising costs and will be turning a relatively high percentage of its income into profit
NET PROFIT/PROFIT COSTS x 100 = x%
eg. 11,000 net profit, 85,000 profit costs
11,000/85,000 x 100 = 12.9%
So it converts income into profit at 12.9%
Gearing ratio - Current Ratio
. Also known as the Working Capital
. Tells whether business is able to pay its debts when due
. Rule of thumb = business should have twice as much current assets as it has current liabilities
. CURRENT ASSETS/CURRENT LIABILITIES = X:1
. eg 30,000 current assets, 20,000 current liabilities
. 30,000/20,000 = 1.5:1
. For every £1 that company owes,in current liabilities, it has £1.50 in current assets to use
. If ratio is more than 2:1, business has much more working capital than it needs and should consider how to use the excess eg paying off loans, expanding
. If ratio is less than 2:1, business may be suffering from cashflow problems so perhaps owner may need to introduce more capital or get a loan
. Uses all current assets to pay current liabilities WIP, debtors, cash and petty cash but might take a while to convert this into cash
Gearing ratio - liquidity ratio
. Also know as Acid Test
Uses Liquid Assets (current assets minus stock/WIP)
. LIQUID ASSETS/CURRENT LIABILITIES = X:1
. eg Current Assets 30,000 inc WIP 18,000, Current Liabilities£20,000
. 30,000 - 18,000/20,000 = 0.6:1
. So for every £1 that firm owes in current liabilities, it has only 60p to pay it off
