1. Accounting Ratios S4 Accounting

2. RATIO ANALYSIS Ratio analysis is the process of determining and interpreting numerical relationship based on financial statements. It is the technique of interpretation of financial statements with the help of accounting ratios derived from the balance sheet and profit and loss account.

3. Basis Of Comparision Trend Analysis involves comparison of a firm over a period of time, that is, present ratios are compared with past ratios for the same firm. It indicates the direction of change in the performance – improvement, deterioration or constancy – over the years. Interfirm Comparison involves comparing the ratios of a firm with those of others in the same lines of business or for the industry as a whole. It reflects the firm’s performance in relation to its competitors. Comparison with standards or industry average

4. Ways To Interpret Accounting Ratios Single absolute ratio. Group ratio. Historical comparision. Inter-firm comparision. Projected ratios.

5. 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

6. 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).

7. 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 Damaged or almost out of date goods.

8. Gross profit to INCREASE. The gross profit can increase. A rise in the gross profit percentage is almost always due to increased efficiency.

9. 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.

10. 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

11. 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

12. 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.

13. Balance Sheet Ratios Return on Capital Invested Working (Current) Capital Ratio

14. 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.

15. 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

16. 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

17. 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.

18. Price Earning Ratio It shows how many times the annual earnings the present shareholders are willing to pay to get a share. This ratio helps investors to know the effect of earnings per share on the market price of the share. This ratio when calculated for several years can be used as term analysis for predicting future price earning ratios and therefore, future stock prices. Average market price per share Average market price per share Price earning ratio= Earning per share Earning per share

19. Earning Per Share This ratio indicates the earning per equity share. It establishes the relationship between net profit available for equity shareholders and the number of equity shares. Net profit available for equity share holders Net profit available for equity share holders Earning per share = Number of equity shares Number of equity shares