1 Ratio Analysis No. 1 Higher Grade Business Management 2009

2 Today’s Ratios  Today we will look at the following ratios in more detail:  Profitability  Gross Profit Margin  Profit Mark-up  Net Profit Margin  Efficiency  Stock Turnover

3 Gross Profit Margin  A reminder of the ratio: GP %=Gross Profit Sales Revenue x 100 1

4 Gross Profit Margin  The purpose - to measure the percentage of profit earned on the trading activities of the organisation.  The Gross Profit Margin measures how many pence Gross Profit is earned from every £1 of sales.

5 Gross Profit Margin  What is a good figure?  It is not possible to comment on what a good figure is without either:  Comparing trends over different time periods.  Making comparisons with other similar organisations.

6 Gross Profit Margin  If the Gross Profit Margin ratio is high, the organisation may have a prudent buying policy.  Changes in the ratio can be caused by an increase or decrease in the selling price or an increase or decrease in the cost of goods sold.

7 Gross Profit Margin  The Gross Profit Margin should be calculated at regular intervals, with any rise or fall investigated.  If the ratio falls it may simply mean that the price of raw materials has gone up.  However it might also mean that stocks have been stolen or damaged.

8 Gross Profit Margin  How can an organisation improve the Gross Profit Margin?  They could:  Raise the selling price.  Look for a cheaper supplier.  Choose to sell something else.  Negotiate better discounts from their suppliers.

9 Profit Mark-up  A reminder of the ratio: Profit Mark-up % =Gross Profit Cost of Goods Sold x 100 1

10 Profit Mark-up  The Profit Mark-up ratio measures the percentage added to the cost of goods sold in order to arrive at the selling price.  No comments can be made on the results without comparing trends or comparisons with competitors.

11 Profit Mark-up  Where the percentage is high, it may indicate a prudent buying policy.  Changes in the ratio can be caused by an increase or decrease in the cost of goods sold (usually outwith the company’s control).

12 Profit Mark-up  How can an organisation improve the Profit Mark-up?  They could:  Raise the selling price.  Look for a cheaper supplier.  Negotiate better discounts from their suppliers.

13 Net Profit Margin  A reminder of the ratio: NP %=Net Profit Sales Revenue x 100 1

14 Net Profit Margin  The purpose - to measure the percentage of overall profit earned by the organisation after all expenses have been taken into account.  The Net Profit Margin measures how many pence Net Profit is earned from every £1 of sales.

15 Net Profit Margin  What is a good figure?  Once again, it is not possible to comment on what a good figure is without either:  Comparing trends over different time periods.  Making comparisons with other similar organisations.

16 Net Profit Margin  The Net Profit Margin is used to highlight efficiency and control of costs.  One question which could be asked is:  Is the organisation making itself bankrupt by paying far too much in wages?

17 Net Profit Margin  How can an organisation improve the Net Profit Margin?  By improving the Gross Profit Margin.  By reducing expenses for example:  Switching off heaters and lights when not in use.  Reducing personal telephone calls by staff.

18 Stock Turnover Ratio  A reminder of the ratio: Stock Turnover=Cost of Sales Average Stock Average Stock is calculated by adding the opening and closing stocks together and dividing by 2

19 Stock Turnover Ratio  Stock turnover is the average period of time that an item of stock is held before it is used or sold.  This ratio usually depends on the type of organisation, for example:  a fast food outlet would turn over its stock many more times a year than a furniture business.

20 Stock Turnover Ratio  If the rate of stock turnover is improving, its likely that the firm is holding lower average stocks and therefore operating more efficiently.

21 Stock Turnover Ratio  How can an organisation improve the Stock Turnover Ratio?  They could:  Introduce special offers or promotions.  Introduce JIT stock management.

22 Task  Using the example of Edward’s Electrical Supplies Ltd, answer the questions based on the ratios covered today.  Remember that for your NAB and final exam, it is important that you are able to describe ratios, give reasons for the results and be able to offer suggestions on how the ratios can be improved.