F Ratios Flashcards
Purposes of ratio analysis
- Compare current years performance with previous years
- Compare performance with other companies
- Highlight areas of the business that require attention
- To aid in future decision making
Limitations of ratio analysis
- The information is historical so there is not much that can be done about it
- External PESTEC factors aren’t taken into account, eg a recession
- Workforce factors aren’t taken into account, eg skills
- Only similar businesses can be compared
- Other businesses may not be willing to provide information
What are the profitability ratios?
Gross profit percentage
Profit for the year percentage
Return on equity employed percentage
What are the liquidity ratios?
Current ratio
Acid test ratio
What are the efficiency ratios?
Rate of inventory turnover ratio
Gross profit percentage
The percentage of profit made from buying and selling goods
gross profit/sales revenue x100
The higher the % the better
How to increase gross profit percentage
By increasing the gross profit by
- Negotiating a better deal with suppliers
- Changing suppliers
- Increasing the price of the product
- Increasing sales by employing more marketing
- Increasing the quality of the product to increase sales
Profit for the year percentage
The percentage of profit made once expenses have been deducted
Profit for the year/Sales revenue x 100
The higher the % the better
How to increase profit for the year percentage
Increase gross profit by
- Changing or negotiating with suppliers
- Employing more marketing
- Improving quality
- Increase prices
Reduce expenses by
- Hiring less employees
- Negotiating better deals with utility suppliers
Return on equity employed percentage
The percentage of investment that is returned to investors such as shareholders
Profit for the year/equity x 100
The higher the % the better
How to increase ROEE percentage
Increase profit for the year by
- Reducing expenses
- Increasing gross profit
Current ratio
Shows how able a business is to pay its short term debts. If it was too low, it would indicate additional finance would be required to pay bills. If it was too high, it would indicate some current assets would be better off be spent on other parts of the business or that too much money is tied up in stock.
current assets/current liabilities : 1
Ideal ration is 2:1
How to increase current ratio
- Reduce current liabilities
- Increase current assets
How to decrease current ratio
- Shift stock by marketing more
- Invest cash in other parts of business
Acid test ratio
Indicates if an organisation is able to pay all its current liabilities in a crisis situation without selling inventory.
1:1 is fine
Current assets - inventory / Current liabilities