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Unit 3 Accounts & Finance

Unit 3 Accounts & Finance. Ratio Analysis. Learning Objectives. To be able to calculate ratios To be able to use ratios to interpret and analyse financial statements from the perspective of various stakeholders

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Unit 3 Accounts & Finance

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  1. Unit 3 Accounts & Finance Ratio Analysis

  2. LearningObjectives • To be able to calculate ratios • To be able to use ratios to interpret and analyse financial statements from the perspective of various stakeholders • HL – To evaluate the possible financial and other strategies to improve the values of ratios

  3. Accounting Ratios Five main groups of ratios • Profitability ratios • Gross Profit Margin • Net Profit Margin • ROCE • Mark-up • Liquidity ratios • Current Ratio • Acid Test Ratio • Financial efficiency ratios • Stock (inventory) Turnover Ratio • Debtor Days Ratio • Creditor Days Ratio • Shareholder or investment ratios • Dividend Yield Ratio • Earnings per share ratio • Gearing ratios • Gearing Ratio Key word – Efficiency How well a firm is using its resources

  4. Profitability Ratios Profitability – How profitable a firm is in relation to sales and assets 1. Profit Margin Ratios • Gross profit margin and net profit margin ratios are used to see how successful a business has been at converting sales revenue into both gross and net profit • They measure the performance of a company and its management team

  5. ProfitMarginRatios Grossprofitmargin (%) = grossprofit sales revenue Net profitmargin (%) = net profit sales revenue You can work out gross profit like this… Total Revenue – Cost of sales X 100 X 100

  6. How to use Gross profit and Net profit margin ratios • Gross profit margin is a good indicator of how effectively managers have ‘added value’ to the cost of sales • It is misleading to compare the ratios of firms in different industries because the level of risk and gross profit margin will differ greatly • When 2 firms are being compared and their gross profit margins are very different but net profit are more alike it suggests one company may have relatively high overheads • Can also compare with previous years

  7. Evalutingwaystoincreaseprofitmargins HL

  8. Profitability Ratios 2. Return on capital employed (ROCE) • Most commonly used means of assessing the profitability of a business – sometimes referred to as the PRIMARY EFFICIENCY RATIO ROCE (%) = net profit capital employed X 100 Capital Employed = (non-current assets + current assets) – current liabilities

  9. 2. Return on capital employed (ROCE) • Higher the value of this ratio, greater the return on the capital invested in the business • The return can be compared with other companies and with the ROCE of previous year’s performance • Result can also be compared with the return from interest accounts (Could the capital be invested in a bank at a higher rate of interest and no risk? • ROCE should be compared with the interest cost of borrowing finance – If it is less than this interest rate, then any increase in borrowings will reduce returns to shareholders • ROCE can only be raised by increasing the profitable, efficient use of the assets owned by the business, which were purchased by the capital employed

  10. Profitability Ratios 3. Mark-Up Ratio • Mark up is the amount of profit added to the cost of sales. • A low mark up might indicate an attempt to increase profit by gaining a larger market share Mark-Up (profit margin) = Gross profit Cost of goods sold X 100

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