The document discusses ratio analysis, which allows businesses to analyze financial reports to inform future decision making. Ratios are presented as percentages or ratios and can assist with decision making, interpreting finances, and assessing profitability, stability, and effectiveness. Specific profitability ratios discussed include gross profit ratio, net profit ratio, and return on equity ratio. Recommendations are provided for improving ratios such as increasing sales, lowering costs of goods sold, minimizing expenses, and ensuring appropriate owner investment levels.

1. Ratios
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2. The analytical technique of ratio analysis
permits businesses to study end of period
reports in order to base decision making for
the future.
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3. RATIOS
 Presented as % or as ratios
 Assist in:
 Decision making
 Interpreting financial figures
 Assessment of enterprise’s:
 Profitability
 Stability
 Effectiveness
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4. Profitability
Profitability is the ability to earn income within the
present financial structure of the enterprise
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5. Profitability Ratios
• Gross Profit Ratio
• Net Profit Ratio
• Return on Equity Ratio
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6. Gross Profit Ratio
Indicates the ability of a
business to retain profit Gross Pr ofit
x100
from sales NetSales
Compare result to
industry benchmarks to
determine suitability of
business performance
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7. 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
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8. High result may indicate:
 ability of business to cover all expenses
 capacity to earn acceptable net profit and
return to owner
Low result may indicate inability to:
 meet further expenses
 Return acceptable net profit
 return satisfactory rate to owner
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9. 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.
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10. Institute policy to lower COGS
 Investigate alternative suppliers selling similar
quality products for less
 Take advantage of discounts offered to lower
costs
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11. Net Profit Ratio
Indicates the
effectiveness of
managers to minimise
expenses per dollar of
sales Net Pr ofit
x100
NetSales
Compare result to
industry benchmarks to
determine suitability of
business performance
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12. 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
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13. High result may indicate:
 High operating revenue
 Low operating expenses
Low result may indicate inability to:
 Inappropriate pricing policy
 Inadequate sales
 Inappropriate stock
 expenses too high
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14. Recommendations
Improve Gross Profit
• as per Gross Profit recommendations
Minimise expenses
• Set budgets for departments
 Investigate alternative suppliers to lower costs
 As per Gross Profit recommendations
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15. Rate of Return on Equity
Ratio
Indicates the rate of
return generated by an
entity on investment of
the owner
Net Pr ofit
Aim for a return of, around, Averageowner 'sequity
x100
14% which allows funding
for future growth and a Owner 'sequitybeg
return on investment.
/2
Owner 'sequityend
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16. 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
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17. 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.
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18. Recommendations
Improve net profit result using previous
recommendations.
Check level of capital invested to ensure
appropriateness 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.
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