Monitoring the Business: Ratios Flashcards
Who uses Financial Information?
- Management
- Shareholders
- Banks
- Trade Unions
- Competitors
- Suppliers
- Employees
- Government
Management
• They will want information to know how the business has performed over the year and to learn if any changes are needed. This will help make decisions if needed
Shareholders
- They will want to know if the money that they have put into the business has been used wisely by the firm in order to generate profits and pay them a dividend
- They want to know how much they can expect in dividends and they also want to know the value and security of their investment
Banks
• They want to know if the business is profitable enough to be able to make loan repayments and interest repayments
Trade Unions
• They will keep an eye on the company’s profits because if they know the business is doing very well, they may look for wage increases. They are interested in the security of employment and the future prospects of the company (will it expand and take on more workers, what are the promotion prospects of the workers)
Competitors
• They will examine a business’s sales and profits to see how big a threat the business is to them
Suppliers
• These are interested in a business’s accounts in order to assess the firm’s credit-worthiness. I.e. can the firm can pay for goods supplied on credit?
Employees
• Will want to see if the firm is performing well for job security and promotion prospects
Government
• Will want to see the performance of the firm to assess how much tax it owes
Trading Account
- The trading account shows the sales, purchases, cost of sales and gross profit of the firm.
- Its main function is to find the gross profit or gross loss a firm made from actually buying and selling goods.
- Sales – Cost of Sales = Gross profit
Sales
This is how much a business sold its products for
Cost of Sales
Opening Stock + Purchases – Closing Stock
This is the cost of buying and making the products.
Gross Profit/Loss
This is the difference between sales and cost of sales.
It is the profit/loss made before any expenses are made.
Profit and Loss Account
gives the Net Profit/Loss- the profit after income has been added and expenses have been taken away.
• The profit and loss account shows the total expenses, such as insurance, rent and rates, light and heat, wages, etc.
• It also shows the dividend paid to shareholders and the retained profit for the year.
• Gross Profit + Income - Expenses
Fixed Assets
These are possessions which a business owns for a long period of time (greater than one year).
eg.: land, buildings, premises
Current Assets
These are short term assets which we own for less than one year.
e.g.: stock, bank, cash
Current Liabilities
Liabilities are all debts that are owed by a business/person and which must be repaid in less than one year.
e.g.: creditors, bank overdraft
Working Capital
Current Asset – Current Liabilities
This measures the liquidity of a firm
Financed By
This is the amount of money invested or put into a business
eg.: long term liabilities, share capital, retained earnings
Long-Term Liabilities
These are debts which will have to be repaid in the long term
I.e. in over one year
Share Capital
This is the money invested (put into) a business by its owners (shareholders). It is made up of
i. Authorised Share Capital
ii. Issued Share Capital
Authorised Share Capital
This is the maximum amount of money a company can raise from selling shares.
Issued Share Capital
This is the actual amount of money that has been raised from issuing shares.
Retained Earnings
These are a firm’s savings.
These are a firm’s profits which have been put aside and left to build up over the past number of years. These can be re-invested in the business in the future and used to help it expand.
Profitability
The profit earned by the business
Liquidity
The ability of the firm to pay its short term debts as they fall due
Gearing (debt/equity
Examines the types of long term capital being used by the firm
Profitability Ratios
- Gross Profit Margin
- Net Profit Margin
- Return on Investment/Return on Capital Employed
Gross Profit Margin
Gross Margin (Gross Profit Percentage)
Gross Profit x 100 = %
————– ———-
Sales 1
Net Profit Margin
Net Profit X 100 = %
———— ————
Sales 1
Return on Investment (ROI) or Return on Capital Employed (ROCE)
Net Profit X 100 = %
————- ———
Capital Employed 1
Liquidity Ratios
- Current Ratio/Working Capital Ratio
2. Acid Test/Quick Ratio
Current Ratio/ Working Capital Ratio
The IDEAL figure should be 2:1.
Current Ratio = Current Assets : Current Liabilities
Acid Test Ratio
The ideal figure is 1:1
Acid Test Ratio: Current Assets- Closing Stock: Current Liabilities
Debt/Equity Ratio / Gearing Ratio
Debt Capital: Equity Capital
Loans: Retained Earnings + Issued Share Capital + Reserves
