Finance - Ratios Flashcards
What is a ratio?
The calculated ratio from the info in both documents to assess a business’ performance from year to year. From the calculated ratios, the sole trader cam interpret figures to show the profitability and solvency of the business
What is the gross profit percentage?
It shows the level of gross profit which a business has made on the sales revenue. It’s a measure of the business’ trading profitability and efficiency.
Gross profit percentage = (gross profit/sales revenue) x 100.
It’s the profit generated after taking account the cost of making the sales.
What is the net profit percentage?
It shows the amount of net profit which is made on sales revenue. It measures the business’ profitability in trading and keeping its expenses down.
Net profit percentage = (net profit/sales revenue) x 100
This is the profit left in the business after the expenses have been considered and indicates if the business is profitable. Net profit percentage can be used by businesses to compare with previous year’s figures of similar businesses.
What is an inventory turnover rate?
It shows the number of times a year that the business is able to sell the value of its average inventory . It’s therefore another measure of the business’ trading efficiency - the higher the rate is, the better the business activity.
Inventory rate = cost of sales / average inventory
A business’ inventory turnover rate will depend on the type of goods that it sells (eg: jewelry shop will have fewer sales for more money)
What is Return on capital employed?
It shows the profitability of the business by comparing the net profit with the capital invested by the owners. It shows the net profit which the owner has received on the capital invested. The owner should compare this result with the profit, which would’ve been received if the money had been invested in shares in other businesses or deposited in the bank
Return on capital employee = (net profit/capital employed) x 100
Capital employed = total assets - total liabilities
The higher this percentage, the more attractive the business would be as an investment .
What is working capital ratio?
It measures the business’ ability to pay its current liabilities such as short-term debt.
Working capital ratio = current assets/current liabilities
For most businesses, suppliers and lenders are the main current liabilities and they can demand to be paid in full whenever they want to. The business must be able to do this if required. Therefore, the working capital ratio must be a minimum of 1 : 1 - this indicates that the business is solvent. The idea, WCR is between 1.5 : 1 and 2 : 1
