# B USINESS P ERFORMANCE What sort of things would you want to know from a set of accounts?

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B USINESS P ERFORMANCE What sort of things would you want to know from a set of accounts?

R ATIO A NALYSIS - W HO WILL USE IT ?  Owners -information to make decisions  Investors -are they getting a fair return on their money?  Suppliers -is the business credit worthy?  Employees -enough profit to pay bonuses, wage rises etc.?  Customers -is the business financially healthy to keep supplying them?  Creditors - such as the bank. Is the business in a position to pay back a loan?

T HE NEED FOR RATIOS Company A Sales£1,927 Gross Profit£400 Company B Sales£1,252 Gross Profit£295 Which company has the ‘best’ profit?

A SSESSING F INANCIAL P ERFORMANCE Profitability Ratios Liquidity Ratios Efficiency Ratios Financial Position Ratios Investor Ratios

R ATIOS ?  Although they are referred to as ratios, many are calculated as a percentage.  Some are calculated as days, some times, and only a few as ratios.

We need a common measure If we do Gross Profit as a proportion of Sales, we can compare the profitability of the two companies. Company A 20.75% Company B 23.56%

 Gross Profit  Expense Margin  Profit from Operations  Net Profit  ROCE  ROI  EPS Profitability Ratios

 Gross Profit  Net Profit  ROCE  Stated as a Percentage Profitability Ratios

P ROFITABILITY  Gross Profit Margin = Gross Profit x 100  Sales  This ratio shows you how much gross profit is being made, and is shown as a percentage of sales.  What could cause the gross profit to change?

P ROFITABILITY  Net Profit Margin = Net Profit x 100  Sales  This ratio shows you how much net profit is being made, and is shown as a percentage of sales.  What could cause the net profit to change?

P ROFITABILITY  Return on Capital Employed (ROCE)  Net Profit for year before interest and tax x 100  Capital Employed  Capital Employed is Fixed Assets plus Current Assets less Current Liabilities  What do you think this ratio is telling us?

CCurrent Ratio QQuick Ratio or Acid Test SStated as a Ratio Liquidity Ratios

L IQUIDITY  We know that working capital is very important. The following ratios are commonly used to measure how solvent the firm is.  What do we mean by Liquidity?

L IQUIDITY RATIOS  Current Ratio = Current assets  Current liabilities  Shows how many times you can cover your current liabilities with your current assets.  Shows the proportion of current assets to current liabilities.  How easily the business could raise the money to pay the debts which are due in the near future.

 A ratio of 2:1 is generally considered to be adequate liquidity, but it depends on the nature of the business.  A liquidity ratio that is too low may indicate that the business may have solvency problems.  What might a liquidity ratio that is too high indicate?

L IQUIDITY RATIOS  Acid test = Current assets minus Stocks  Current liabilities  For this ratio we take the stocks out of the current assets as stocks may take a long time to convert into cash to pay debts.  A result of less than 1:1 indicates that a business could have problems paying its debts.

 Debtor days  Creditor Days  Stock Turnover  Fixed Asset Turnover  Cash Cycle Efficiency Ratios

 Debtor days  Creditor Days  Stock Turnover  Stated as Days or Time Efficiency Ratios

E FFICIENCY  Debtors Payment Period  Debtors x 365  Credit sales for the year  This ratio shows the debtors collection period in days. If you are not sure which sales were on credit, just use the sales figure from the P&L account.  This ratio shows on average how long it takes debtors to pay for goods bought on credit.  What is happening if the number of days is increasing?

E FFICIENCY  Creditors Payment Period  Creditors x 365  Credit purchases for the year  This ratio shows the credit payment period in days. If you are not sure which purchases were on credit, just use the purchases figure from the P&L account.  This ratio shows on average how long it takes the business to pay for goods bought on credit.  What is happening if the number of days is increasing?

E FFICIENCY  Rate of Stock Turnover Average stock x 365 = stock turnover in days Cost of goods sold  (Average stock is calculated by adding together opening and closing stock and dividing by 2)  This ratio tells you the average amount of time items of stock are held in the business.  Is it better to have a high rate of stock turnover or a low one? Why?

 Gearing Ratio  Interest Cover Financial Position Ratios

G EARING R ATIO  Measure of how much of the long term capital in the company is provided by outside parties (eg long term bank loans, debentures)  Different ways to calculate but usually  Long term debt x 100  Long term debt + equity

I NTEREST C OVER  Shows how many times the business is able to pay interest charges out of the operating profit.  If interest cover falls, because either profitability is falling or interest charges are rising, it may indicate a future inability to meet interest charges as they become due.  This ratio is an indicator for profitability, level of borrowing and liquidity  Profit before interest and tax=times  Interest

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