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Ratio Introduction 100 CMD
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Ratio Introduction 100 CMD

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  • 1. Introduction to Ratio Analysis Higher/Int 2 Business Management 2009-2010
  • 2. Why Do We Need Ratios?
    • Taken on their own , figures from final accounts can be confusing .
    • However, when financial ratios are used to analyse the information more closely, the figures become clearer .
    • Accounting ratios are used as a tool in the decision-making process and as an aid to financial interpretation and planning .
  • 3. Analysis is the Key!
    • Ratios are no use on their own. They must be compared to:
      • Previous ratios , in order to see trends .
      • Competitors , to check competitiveness .
  • 4. Types of Ratio
    • Ratios can inform us about three main areas of final accounts:
      • Profitability
      • Liquidity
      • Efficiency
  • 5. Types of Ratio
    • Profitability
      • Is the organisation earning more than it is paying in costs ?
    • Liquidity
      • Does the organisation have enough money to pay its bills ?
    • Efficiency
      • Is the organisation making best use of its resources ?
  • 6. Types of Ratio: Profitability
    • Gross Profit Margin
    • Profit Mark-up
    • Net Profit Margin
  • 7. Types of Ratio: Liquidity
    • Current Ratio
    • Acid Test Ratio
  • 8. Types of Ratio: Efficiency
    • Return on Capital Employed
    • Rate of Stock Turnover
  • 9. Gross Profit Margin
    • This ratio relates gross profit to sales revenue :
    • GP % = Gross Profit
    • Sales Revenue
    x 100 1
  • 10. Gross Profit Margin
    • Using the example of Gill’s Gym Equipment Ltd for 2003:
    • GP % = 90,000 (Gross Profit)
    • 850,000 (Sales Revenue)
    • = 10.6 %
    x 100 1
  • 11. Profit Mark-up
    • This ratio is used to calculate the gross profit as a percentage of cost of goods sold :
    • Profit Mark-up % = Gross Profit
    • Cost of Goods Sold
    x 100 1
  • 12. Profit Mark-up
    • Using the example of Gill’s Gym Equipment Ltd for 2003:
    • Profit Mark-up % = 90,000 (Gross Profit)
    • 760,000 (Cost of Goods Sold)
    • = 11.8 %
    x 100 1
  • 13. Net Profit Margin
    • This ratio relates net profit to sales revenue :
    • NP % = Net Profit
    • Sales Revenue
    x 100 1
  • 14. Net Profit Margin
    • Using the example of Gill’s Gym Equipment Ltd for 2003:
    • NP % = 25,000 (Net Profit)
    • 850,000 (Sales Revenue)
    • = 2.9 %
    x 100 1
  • 15. Current Ratio
    • The Current Ratio is also known as the Working Capital Ratio .
    • The Current Ratio is used to indicate a business’s ability to meet its short term debts without having to borrow money.
  • 16. Current Ratio
    • The formula for the Current Ratio is:
    • Current Assets : Current Liabilities
    • For Gill’s Gym Equipment in 2003:
    • 550 : 250
    • This can be simplified: 2.2 : 1
  • 17. Acid Test (Quick) Ratio
    • The Acid Test Ratio is similar to the Current Ratio although it takes into account the fact that stock may take some time to be turned into cash .
    • (Current Assets - Stock) : Current Liabilities
  • 18. Acid Test (Quick) Ratio
    • Using the example of Gill’s Gym Equipment Ltd for 2003:
    • Acid Test = (550 - 300) : 250
    • = 1 : 1
  • 19. Return on Capital Employed
    • R eturn on capital employed relates profitability to the capital invested in a business:
    • ROCE % = Net Profit
    • Capital Employed
    x 100 1
  • 20. Return on Capital Employed
    • Using the example of Gill’s Gym Equipment Ltd for 2003:
    • ROCE % = 25,000 (Net Profit)
    • 900,000 (Capital Employed)
    • = 2.8 %
    x 100 1
  • 21. Stock Turnover Ratio
    • The purpose of this ratio is to give the number of times per period that the average stock is sold .
    • Stock Turnover = Cost of Sales
    • Average Stock
    • Average Stock is calculated by adding the opening and closing stocks together and dividing by 2
  • 22. Stock Turnover Ratio
    • Using the example of Gill’s Gym Equipment Ltd for 2003:
    • Stock Turnover = 760,000
    • 275,000
    • = 2.76 Times
    • Note: Average Stock = (250 + 300) / 2 = 275
  • 23. Uses of Ratio Analysis
    • Ratio analysis can provide the following information:
      • Current performance relative to previous performances (intra-firm).
      • Current performance relative to that of competitors (inter-firm).
      • Why performance changes occur and how to improve.
      • Information for budgeting .
  • 24. Limitations of Ratio Analysis
    • Accounting information used is historical and so can be irrelevant to the future.
    • Any comparisons must be made with firms of similar size in the same industry .
    • Findings may not take into account external factors .
    • Different stock valuation methods can result in different figures.
    • Ratios do not show other elements such as staff morale or staff turnover .
  • 25. Task
    • Calculate the ratios that we have covered today for Gill’s Gym Equipment Ltd in 2004.