Ratios Flashcards
Gross profit percentage measures…
The percentage of sales revenue that is gross profit (% profit made from buying and selling)
Gross profit percentage calculated as…
Gross profit/sales revenue x100
Profit for the year percentage measures…
The percentage old sales revenue that is profit for the year (% profit after deducting expenses)
Profit for the year percentage calculated as…
Profit for the year/sales revenue x100
Return on equity employed (ROEE) measures the…
PFTY as a percentage of the owners equity in the firm and shows the % investment returned to shareholders
ROEE calculated as…
Profit for the year/ owners equity x100
Profitability ratios are…
Gross profit percentage
Profit for the year percentage
ROEE
Is the org earning more than it is paying out.
What changes gross profit?
Change in sales
Selling price
Price of raw materials
What changes PFTY?
Changes in gross profit
Changes in other expenses
What changes ROEE?
Changes in PFTY
Raw material costs
Changes in equity (share issue)
Sales
Expenses
Efficiency ratios question whether…
The org is making the best of its resources
Rate of inventory turnover
Rate of inventory turnover measures…
The number of times in accounting period the org buys and sells its inventory (turnover)
The
The higher the RIT the…
More efficient the org is in managing its inventory
RIT is calculated as…
Cost of sales/average inventory*
*opening and closing inventory/2
Ways to improve low rate of inventory turnover are…
Reduce average inventory by holding lower levels of stock at any time- so lower minimum level
Use promotion to shift surpluses and reduce closing inventory
Switch to just in time method so inventory arrives just in time to go directly into production
Liquidity ratios are…
Current ratio
Acid test ratio
Current ratio measures…
The proportion of current assets to current liabilities and showing how quickly the business can repay its short term debts
A safe current ratio is…
2:1
Current ratio calculation is…
Current assets/current liabilities
Acid test ratios measure…
The proportion of current assets less inventory to current liabilities and whether it’s possible to turn inventory into cash quick enough
Acid test ratio is calculated by…
(Current assets-inventory)/current liabilities :1
Current ratio can be improved by…x5
Improving current assets by:
Selling off non current assets- turn into cash
Better inventory control-reduce scrapping
Better credit control- reduce loss of trade receivables
Seek longer term finance and put some funds into the bank
Reduce current liabilities by…
Seeking longer term finance e.g. loans, share issue to pay off short term debts
Advantages of ratios are…x6
Calculates profitability efficiency and liquidity
Easier to understand than the raw data figures and easier to manage and remember
Compares the performance of the business with previous years and competitors
Compares against market averages/industry averages
Can identify trends
Highlights areas requiring attention
Disadvantages of using ratios are…x6
Historical so not relevant to current or future position
Doesn’t take into account external factors e.g. economic recession
Doesn’t take into account internal factors e.g. staff morale
Doesn’t take into account company developments e.g. new or deleted products
Difficult to find exactly similar competitors to make comparisons
Figures cannot be used in isolation as you need to understand where figures come from
Liquidity ratios analyse…
How the business has performed over the time period in the use of its assets and control of its debts
When the current ratio is too high…
Indicates there is more than enough money to cover short-term debts. Too much cash can indicate that it isn’t being used his best advantage and spare car should be reinvested to an extra income for the business
When the current ratio is low…
Indicates that the business may have the liquidity problems
Ways of improving PFTY are…x4
Decrease expenses e.g. layoff temporary workers
Use marketing strategies to improve sales
Increase selling price to improve profit markup
Find a cheaper supplier of raw materials
Ways of improving gross profit are…x3
Increase selling price which improves my cup
Increased sales revenue by implementing new advertising campaigns
Find a cheaper supplier
The acid test ratio assumes that stock…x4
May be perishable
May go out of date
Make away to fashion or become obsolete
Which means the business might be left with stock it can’t sell
