Earning capacity ratios
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Earning capacity ratios

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Earning capacity ratios Earning capacity ratios Presentation Transcript

  • Ratios 1
  • The analytical technique of ratio analysispermits businesses to study end of periodreports in order to base decision making forthe future. 2
  • RATIOS Presented as % or as ratios Assist in:  Decision making  Interpreting financial figures  Assessment of enterprise’s:  Profitability  Stability  Effectiveness 3
  • ProfitabilityProfitability is the ability to earn income within thepresent financial structure of the enterprise 4
  • Profitability Ratios• Gross Profit Ratio• Net Profit Ratio• Return on Equity Ratio 5
  • Gross Profit RatioIndicates the ability of abusiness to retain profit Gross Pr ofit x100from sales NetSalesCompare result toindustry benchmarks todetermine suitability ofbusiness performance 6
  • Result indicates: for every $ of sales – indicates the number of cents retained as gross profit how effective business is in passing on increases in COGS to customers 7
  • High result may indicate: ability of business to cover all expenses capacity to earn acceptable net profit and return to ownerLow result may indicate inability to: meet further expenses Return acceptable net profit return satisfactory rate to owner 8
  • Recommendations Improve sales  Ascertain:  Stock levels - should be high enough to meet demand  appropriateness of stock to appeal to market  demand for stock held  Appropriateness of selling price  Conduct market research/analysis to assist with the above. 9
  • Institute policy to lower COGS Investigate alternative suppliers selling similar quality products for less Take advantage of discounts offered to lower costs 10
  • Net Profit RatioIndicates theeffectiveness ofmanagers to minimiseexpenses per dollar ofsales Net Pr ofit x100 NetSalesCompare result toindustry benchmarks todetermine suitability ofbusiness performance 11
  • Result indicates: for every $ of sales – number of cents retained as net profit how effective business is in minimising expenses poor GP ratio will impact on NP ratio 12
  • High result may indicate: High operating revenue Low operating expensesLow result may indicate inability to: Inappropriate pricing policy Inadequate sales Inappropriate stock expenses too high 13
  • RecommendationsImprove Gross Profit• as per Gross Profit recommendationsMinimise expenses• Set budgets for departments Investigate alternative suppliers to lower costs As per Gross Profit recommendations 14
  • Rate of Return on EquityRatioIndicates the rate ofreturn generated by anentity on investment ofthe owner Net Pr ofitAim for a return of, around, Averageowner sequity x10014% which allows fundingfor future growth and a Owner sequitybegreturn on investment. /2 Owner sequityend 15
  • High result may indicate: Efficient operations business may be under capitalised(owner has not contributed equity to the optimum level)  Under-capitalisation can be identified when NP ratio is close to or under industry benchmark yet ROE is well above industry benchmark 16
  • Low result may indicate: owner’s money may perform better invested elsewhere business may be over capitalised (if owner has invested over the optimum sum into the business)  Can be identified when NP ratio is close to industry benchmark yet the ROE result is well below industry benchmark management may take little risk therefore business is cautiously managed inefficient management making poor decisions, lack of vision. 17
  • RecommendationsImprove net profit result using previousrecommendations.Check level of capital invested to ensureappropriateness for industry.  If under-capitalised owner should consider investing more funds into the business.  If over-capitalised owner should consider investing excess funds into alternative investments. 18