1. RATIO ANALYSIS

2. RATIO ANALYSIS
Ratios can be used analyse a business and to compare the performance of a business between years and with other similar businesses.
Ratios can be broadly divided into 3 main types, profitability ratios, liquidity ratios and efficiency ratios.

3. PROFITABILITY RATIOS USED TO ANALYSE INCOME STATEMENTS
The 3 main profitability ratios used to analyse trading profit and loss accounts are the
GROSS PROFIT PERCENTAGE
NET PROFIT PERCENTAGE
RETURN ON CAPITAL EMPLOYED

4. GROSS PROFIT PERCENTAGE
A Trader
Trading, Profit and Loss Account for year ending 31 March 2001
Sales £250,000
Cost of Sales £90,000
Gross Profit £160,000
Expenses £100,000
Net Profit £ 60,000
The gross profit percentage of the business A Trader is
Gross Profit
Sales
X 100 =
£160,000
X 100 =
£250,000 =
64%

5. WHAT CAUSES GROSS PROFIT PERCENTAGE TO CHANGE?
A Trader
Trading, Profit and Loss Account for year ending 31 March 2001
Sales £250,000
Cost of Sales £90,000
Gross Profit £160,000
Expenses £100,000
Net Profit £ 60,000
A Trader
Trading, Profit and Loss Account for year ending 31 March 2002
Sales £250,000
Cost of Sales £100,000
Gross Profit £150,000
Expenses £100,000
Net Profit £ 50,000
The gross profit percentage fell for the above business from 64% to 60%. Changes in this ratio can only come about when there is a change in the selling price and or a change in the price of goods bought for sale. For A Trader the gross profit percentage decreased because cost of sales increased.

6. HOW CAN A BUSINESS IMPROVE ITS GROSS PROFIT PERCENTAGE?
A business can improve its gross profit percentage by increasing the mark-up. Mark-up is the amount added to the cost price of goods to arrive at their selling price, or put more simply by increasing selling price. Gross profit % can also be improved by paying a lower price for goods purchased and by keeping selling price the same or making it higher.
Year Cost Mark-up Selling Gross Gross
Price Price Profit Profit %
1 £ £1 £3 £1 33%
2 £ £2 £4 £2 50%
3 £ £3 £4 £3 75%

7. NET PROFIT PERCENTAGE
Profit for the Year
Net Profit % =
X 100
Sales
This ratio tells us how much net profit is being made on each £1 of sales, eg if net profit is 15% then 15 p has been made on each £1 of sales.

8. Trading, Profit and Loss Account for year ending 31 March 2001
NET PROFIT PERCENTAGE
A trader
Trading, Profit and Loss Account for year ending 31 March 2001
Sales £250,000
Cost of Sales £90,000
Gross Profit £160,000
Expenses £100,000
Profit for the year £ 60,000
The net profit percentage of the business A Trader is
Net Profit
Sales
X 100 =
£60,000
£250,000
X 100 = =
24%

9. WHAT CAUSES NET PROFIT PERCENTAGE TO CHANGE?
A Trader
Trading, Profit and Loss Account for year ending 31 March 2001
Sales £250,000
Cost of Sales £90,000
Gross Profit £160,000
Expenses £100,000
Net Profit £ 60,000
A Trader
Trading, Profit and Loss Account for year ending 31 March 2002
Sales £260,000
Cost of Sales £100,000
Gross Profit £160,000
Expenses £ 90,000
Net Profit £ 70,000
The net profit percentage improved from 24% to 27%. Net profit percentage can change when anything which affects net profit changes ie changes in gross profit, changes in sales revenue and or changes in expenses.

10. HOW CAN A BUSINESS IMPROVE ITS NET PROFIT PERCENTAGE?
A Trader
Trading, Profit and Loss Account for year ending 31 March 2001
Sales £250,000
Cost of Sales £90,000
Gross Profit £160,000
Expenses £100,000
Net Profit £ 60,000
A Trader
Trading, Profit and Loss Account for year ending 31 March 2002
Sales £260,000
Cost of Sales £100,000
Gross Profit £160,000
Expenses £ 90,000
Net Profit £ 70,000
A business can improve its net profit percentage by taking actions which will improve its sales income eg through increased and improved advertising and promotion, or by changes in price. It could also reduce expenses.

11. Below are details of A Carters Accounts
Below are details of A Carters Accounts. For Year 1 and Year 2 calculate Gross Profit Percentage and Net Profit Percentage. Explain any changes in these figures.
Year 1 Year 2
£000 £000
Sales (net)
Cost of goods sold
Opening inventory
Closing inventory
Expenses
Opening capital
Current assets
Current liabilities

12. Below are details of A Carters Accounts
Below are details of A Carters Accounts. For Year 1 and Year 2 calculate Gross Profit Percentage and Net Profit Percentage. Explain any changes in these figures.
Year 1 Year 2
£000 £000
Sales (net)
Cost of goods sold
Gross Profit
Gross Profit % 31% 28%
Expenses
Profit for the year
Net Profit % 13% 8%

13. Below are details of A Ford Accounts
Below are details of A Ford Accounts. For Year 1 and Year 2 calculate Gross Profit Percentage and Net Profit Percentage. Explain any changes in these figures. You will need to calculate Gross Profit and Net Profit first.
Year 1 Year 2
£000 £000
Sales (net)
Cost of goods sold
Opening inventory
Closing inventory
Expenses
Opening capital
Current assets
Current liabilities

14. Below are details of A Ford Accounts
Below are details of A Ford Accounts. For Year 1 and Year 2 calculate Gross Profit Percentage and Net Profit Percentage. Explain any changes in these figures. You will need to calculate Gross Profit and Net Profit first.
Year 1 Year 2
£000 £000
Sales (net)
Cost of goods sold
Gross Profit
Gross Profit %
Expenses
Profit for the year
Net Profit %

15. Below are details of A Ford Accounts
Below are details of A Ford Accounts. For Year 1 and Year 2 calculate Gross Profit Percentage and Net Profit Percentage. Explain any changes in these figures. You will need to calculate Gross Profit and Net Profit first.
Year 1 Year 2
£000 £000
Sales (net)
Cost of goods sold
Gross Profit
Gross Profit % 27% 29%
Expenses
Profit for the year
Net Profit % 9% 9%

16. RETURN ON CAPITAL EMPLOYED
Profit for the year
Return on Capital Employed =
X 100
Capital at start
The return on capital percentage tells us how much profit a business has made as a percentage of the capital invested in it and gives an indication of how profitable the business is. The higher the percentage the more profitable the business.

17. RETURN ON CAPITAL
Statement of Financial Position
as at 31 March 20..
Non Current Assets £ £
Premises ,000
Machinery ,000
Equipment ,000
285,000
Current Assets
Inventory 1,000
Trade Receivables 2,000
Bank 5,000
8,000
Current Liabilities
Trade Payables 4,000
WORKING CAPITAL ,000
NET ASSETS ,000
Financed by
Capital 1 April ,000
Net Profit , ,000
The return on capital taken from the balance sheet on the left is
Net Profit =
X 100
Capital
£29,000 =
X 100
£260,000 =
11%

18. Year 1 Year 2 £000 £000 Net Profit 35 50 Capital at start 100 120
Below are details of A Ford Accounts. For Year 1 and Year 2 calculate Return on Capital Employed for each year and comment on the change.
Year 1 Year 2
£000 £000
Net Profit
Capital at start

19. Year 1 Year 2 £000 £000 Net Profit 35 50 Capital at start 100 120
Below are details of A Ford Accounts. For Year 1 and Year 2 calculate Return on Capital Employed for each year and comment on the change.
Year 1 Year 2
£000 £000
Net Profit
Capital at start
Return on Capital
Employed % 35% 42%

20. The ratio that show the liquidity of the business are:
LIQUIDITY RATIOS
The ratio that show the liquidity of the business are:
CURRENT RATIO

21. CURRENT RATIO
Current Ratio =
Current Assets
Current Liabilities
This ratio tells us if a business has enough funds to pay its debts and sufficient working capital. If a business has a current ratio of 2:1 it has £2 of current assets for every £1 of current liabilities. It is solvent, it can pay its way, and has enough left over to pay its running expenses.

22. CURRENT RATIO = = = The current ratio of the business on the left is
Statement of Financial Position
as at 31 March 20..
Non Current Assets £ £
Premises ,000
Machinery ,000
Equipment ,000
285,000
Current Assets
Inventory 1,000
Trade Receivables 2,000
Bank 5,000
8,000
Current Liabilities
Trade Payables 4,000
WORKING EQUITY 4,000
NET ASSETS ,000
Financed by
Equity 1 April ,000
Net Profit , ,000
The current ratio of the business on the left is
Current Assets
Current Liabilities =
£8,000 =
£4,000
2:1 =

23. The ratios that show how efficient the business is are:
EFFICIENCY RATIOS
The ratios that show how efficient the business is are:
RATE OF STOCK TURNOVER
EXPENSES RATIO
DEBTORS COLLECTION PERIOD
CREDITORS COLLECTION PERIOD
FIXED ASSET TURNOVER

24. Rate of Stock Turnover =
Cost of Goods Sold
Average Stock
The Rate of Stock Turnover shows how many times a business sells its stock in a year. The higher the rate of turnover the better it is for the business as this means it is earning its profits quicker.

25. RATE OF INVENTORY TURNOVER
Cost of Goods Sold
Average Inventory
Before the rate of stock turnover can be worked out the average stock held by the business must be found.
Average
Inventory =
Opening Inventory + Closing Inventory 2

26. RATE OF INVENTORY TURNOVER Trading Account for year ending
To calculate RoS for this business average stock must be found first Average inventory =
Trading Account for year ending
31 March Year 1
Sales £250,000
Opening
Inventory £15,000
Purchases £80,000
£95,000
Closing
Inventory £5,000
Cost of Sales £90,000
Gross Profit ,000
Opening Inv + Closing Inv 2
£15,000 + £5,000 = 2 =
£10,000
Cost of Goods Sold =
Average Inventory
£90,000 =
£10,000 =
9 times

27. CAUSES OF CHANGES IN RATE OF INVENTORY TURNOVER
The rate of inventory turnover will change if the number of goods sold by the business changes. Changes in the demand for a business’s products can be caused by
price changes causing more or less people to buy
advertising and promoting more or less than previously
other businesses competing more or less effectively
out of date inventory
To increase its rate of inventory turnover a business could try changing price or promoting and advertising more or stocking different products.

28. EXPENSES RATIO
X 100
Expenses Ratio =
Expenses
Sales

29. CREDITOR’S PAYMENT PERIOD Creditors’ Payment Period
Average Creditors x 365
Total Credit Purchases

30. DEBTOR’S COLLECTION PERIOD
Average Debtors x 365
Total Credit Sales

31. NON CURRENT ASSET TURNOVER
Net Turnover
Non Current Assets at Book Value