Interpretation of Financial
Importance of Financial Ratios
Ratios show important relationships between
Compares business’ performance over several
Compare the business’ performance with that of
other businesses within the same industry.
Help to assess the profitability of the business by giving
an indication of the level of return the owner is getting.
Gross profit margin
Mark-up on cost
Net profit margin
Rate of return on capital
Efficiency Ratio: Help assess efficiency in the
use of business assets/resources.
Rate of stock turn or Rate of stock turnover
Percentage of expense to turnover
Liquidity Ratios: Indicate business’ ability to
pay its debts and manage its working capital
Working capital ratio or current ratio
Mark-up: gross profit as a % of cost of
In this case the profit made is $44 per $100 spent.
Gross profit margin: Gross profit as a %
Net profit margin: Net profit as a % of
Rate of Stock turn
• Also known as Rate of stock turnover
• No. of times in a year the average stock can be sold off
Amount of capital uses to day-to-day running expenses of a business.
Working Capital= Current Assets- Current Liabilities
Working Capital Ratio also known as Current Ratio indicates the ability
of the business pay its bills/ meet all its expenses as they fall due.
Working capital ratio
Also known as liquid ratio or acid test ratio.
• Also known as owner’ capital
Capita Employed( Net worth)
• It is the amount of money actually being used in the business,
regardless to whom it belongs.
• Capital Employed= Owner’s Equity+ Long term Liabilities
Example: xyz’s owners equity is $1,300,000 and long term
liabilities(Long term Loan) is $20,000
Capital Employed= $1,30,0000+$20,000=$1,32,0000
Rate of return on capital
• It is the net profit as a percentage of capital at the beginning of the
• Every business will carry out a physical stock-take ie. count the units
of goods not sold.
• Physical stock-take is important to many businesses because close
stock may be a main component current assets. Incorrect valuation
will affect the true and fair value of the assets of the business.
• Incorrect valuation closing stock will affect cost of sales of the
business, in turn affecting the gross profit and net profit current year
as well as the subsequent year since the closing stock of the current
year is taken as the opening stock of the following year.
Basis of stock valuation
• Cost or net realizable value whichever is LOWER.
• Cost =purchase price+ all the other expenses incurred in bringing the
goods to the current location
• Net realizable value =amount received from the sale of stock after
deducting all expenses that will be incurred in selling the goods.
• Example: If the cost price of the stock is $50000 and the net realizable
value(current market price) is $45000, the sock will be valued at
• The concept of conservatism is considered in this case.