Accounting Ratios


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Accounting Ratios

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 Damaged or almost out of date goods.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