Accounting Ratios


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Accounting Ratios

  1. 1. Accounting Ratios S4 Accounting
  2. 2. Profitability Ratios These ratios are calculated using the Profit & Loss: Gross Profit as a Percentage of Net Sales Net Profit as a Percentage of Net Sales Rate of Stock Turnover
  3. 3. Gross Profit as a Percentage of Net Sales The GP Percentage is used to calculate what the gross profit is in relation to the sales of a business. The GP Percentage on turnover is calculated using the formula: Gross Profit x 100 Net Sales (Remember sales - sales returns = net sales).
  4. 4. Reasons for gross profit DECREASE? Cash losses: theft or wrong amounts being rung up on the till. Stock losses: theft of stock by employees or passing of stock to friends. Expenses: Utilities can increase such as gas and electricity prices. Mark downs: Reductions in selling price. Damaged or almost out of date goods.
  5. 5. Gross profit to INCREASE. The gross profit can increase. A rise in the gross profit percentage is almost always due to increased efficiency.
  6. 6. Rate of Stock Turnover The Rate of Stock Turnover is very important. When a company turns over stock - profit is made. Stock has turned over when it has been sold and replaced with new stock. The higher a company turns over stock the greater the profits should be. Stock Turnover is always expressed as a number followed by the word times.
  7. 7. If your Rate of Stock Turnover is 4 times then the company would have turned the stock over every 3 months. We calculate the Rate of Stock Turnover with the following formula: Cost of Goods Sold Average Stock * * To calculate Average Stock Opening Stock + Closing Stock
  8. 8. Net Profit as a Percentage of Net Sales The Net Profit Percentage indicates how well a business has controlled their overheads. The Net Profit is calculated by deducting the total expenses from the gross profit. We calculate the Net Profit Percentage of Net Sales with the following formula: Net Profit x 100 Turnover
  9. 9. If there is little difference between the gross and net profit percentages this indicates that the business has been able to control its overheads efficiently.
  10. 10. Balance Sheet Ratios Return on Capital Invested Working (Current) Capital Ratio
  11. 11. Return on Capital Invested The most important ratio calculated by the owner of a business. Return on Capital Invested compares profit earned in the year with the capital invested in the business. A good Return on Capital is essential to any business.
  12. 12. Poor returns on capital should make the owners or partners think whether continuing with the business is a good idea. To calculate the Return on Capital Invested we use the formula: Net Profit x 100 Capital at Start
  13. 13. Working (Current) Capital Ratio The Working Capital Ratio or Current Ratio focuses on the relationship between a businesses current assets and current liabilities. The formula to calculate this ratio is: Current Assets Current Liabilities
  14. 14. A business must never run short of working capital. This is a very popular cause for business failures. If a business has a ratio of less than 1:1 then in effect it is insolvent. Low ratio indicates a lack of working capital. High ratio indicated there may be too much working capital. Too much money tied up in stock or other assets.