1. Special Accounting Procedures
Chapter 5

2. What ratios I need to know
Gross profit margin
Net profit margin
Gross profit markup
Return On Capital Employed (ROCE)
Current ratio
Acid test ratio (quick ratio)
Debtor to sales ratio
Creditors to purchases ratio
Rate of stock turn over ratio
Profitability ratios
Liquidity ratios

3. Gross profit margin Gross profit margin (%) = Gross profit margin
Sales
X 100
Shows how much gross profit is made for every $ earned

4. Calculations Sales turnover X 100 42,000 50,000 X 100฿
Sales turnover 50,000
Cost of Sales 8,000
Gross profit
Expenses
Rent 15,000
Utility bills 4,000
Wages 10,000
Net profit
Gross profit
margin (%) =
Sales turnover
X 100
42,000
Gross profit
margin (%) =
42,000
50,000
X 100
13,000
=84%
Analysis
For every baht (฿) make from sales, 84% is kept as gross profit

5. Net profit margin Net profit margin (%) = Net profit margin Net profit
Sales turnover
X 100
Shows how much Net profit is made for every $ earned

6. Calculations Sales turnover X 100 5,000 80,000 X 100฿
Sales turnover 80,000
Cost of Sales 20,000
Gross profit
Expenses
Rent 35,000
Utility bills 10,000
Wages 10,000
Net profit
Net profit
margin (%) =
Sales turnover
X 100
60,000
Net profit
margin (%) =
5,000
80,000
X 100
5,000
=6%
Analysis
For every baht (฿) make from sales, 6% is kept as Net profit profit

7. Gross profit markup
This ratio shows the percentage of profit to the cost of goods sold. In other words, the amount the owner has ‘marked up’ its products.
GP mark up=
Gross profit
Cost of goods sold
X 100
If a product cost £1 and the owner wants a 20% mark up. Then the product will be sold for £1.20

8. Return On Capital Employed
ROCE (%) =
Operating profit
Capital employed
X 100
Shows how successful the managers are at earning a profit from capital used in the business.

9. Calculations Operating profit Capital employed X 100 ROCE (%) = 10,000
Fixed assets ฿
Land 10,000
Vehicle 5,000
Machines 1,000
Current Assets
Debtors 1,000
Cash 500
Stock 2,000
Current Liabilities
Creditors 600
Bank loan 800
Net-Current Assets
(Working capital)
Net assets
Financed by:
Profit / Loss 10,000
Share capital 8,100
Capital employed
Return on Capital Employed
ROCE (%) =
Operating profit
Capital employed
X 100
ROCE (%) =
10,000
18,100
X 100
2,100
=55%
Analysis
For every baht (฿) invested, the business makes 55% extra.
18,100
18,100

10. Current ratio Current ratio = Current Ratio Current assets
Current liabilities
Shows haw many times a business can pay its short term debts with current assets.
A good current ratio would be between 1.5 : 1 – 2 : 1 A ratio less than 1 would mean that a business could not pay its short term debts, and could be forced to cease trading. (It has no working capital)

11. Calculations Current ratio Current assets Current liabilities
Fixed assets ฿
Land 10,000
Vehicle 5,000
Machines 1,000
Current Assets
Debtors 1,000
Cash 500
Stock 2,000
Current Liabilities
Creditors 600
Bank loan 800
Net-Current Assets
(Working capital)
Net assets
Financed by:
Profit / Loss 10,000
Share capital 8,100
Capital employed
Current ratio
Current ratio =
Current assets
Current liabilities
Current ratio =
3,500
1,400
2,100
=2.5:1
Analysis
2.5:1 means the business can pay it’s short term debts two and a half times. It has high liquidity!
18,100
18,100

12. Acid test (Quick Ratio)
Acid test ratio OR Liquidity ratio
Acid test =
Current assets – stock
Current liabilities
Similar to current ratio, however without stock because the nature of some companies may mean it is difficult to sell stock quickly (their stock is not liquid) for example a estate agent / car sales.
A good acid test ratio is between 0.5 : 1 – 1 : 1

13. Calculations Acid test Current assets - stock Current liabilities
Fixed assets ฿
Land 10,000
Vehicle 5,000
Machines 1,000
Current Assets
Debtors 1,000
Cash 500
Stock 50,000
Current Liabilities
Creditors 600
Bank loan 800
Net-Current Assets
(Working capital)
Net assets
Financed by:
Profit / Loss 10,000
Share capital 8,100
Capital employed
Acid test
Acid test ratio =
Current assets - stock
Current liabilities
Acid test ratio =
1,500
1,400
50,100
=1:1
Analysis
1:1 means the business can JUST pay it’s short term debts. It has virtually no Liquidity!
79,600
18,100

14. Debtor to Sales ratio Debtors to sales ratio=
This ratio assesses how long it takes for debtors to pay what they owe.
Debtors to sales ratio=
Debtor value
Total annual sales
X 12
The higher the ratio, the worse the business is at getting its debtors to pay on time. The lower the ratio, the better it is at managing its debtors.

15. Debtor to Sales ratio Business A Business B
Total sales $240,000 $180,000
Debtor value $60,000 $30,000
Calculate the debtor to sales ratio.
It is important to ensure debtors pay on time because:
The longer the debt is owed, the more likely it is to turn into a bad debt
The longer the debt is owed, the less working capital the business will have

16. Creditors to purchases ratio
This ratio shows how long on average it takes a business to pay its suppliers
Creditors to purchases ratio=
Creditor value
Annual purchases
X 12
Taking longer to pay suppliers could be a good thing or a bad thing depending on the circumstances.
If you take a long time to pay, you may lose possible discounting, or gain a bad reputation, in which case the supplier may not sell you goods any more.
However, if you do not pay straight away, you keep more money in the business, increasing your working capital.

17. Creditors to purchases ratio
Business A Business B
Total purchases $120,000 $90,000
Creditor value $40,000 $22,500
Calculate the creditor to purchases ratio.

18. Rate of stock turn over ratio
Every business should aim to keep their stock low (reduces storage costs) and should aim to sell their stock quickly. The stock turnover ratio measures how successful a business is at ‘managing’ their stock.
Cost of goods sold
Average stock held
Stock turnover ratio=
If only the opening and closing stocks are known, the average stock is found by adding opening and closing stock together and dividing them by two.
The higher the ratio, the more profitable the business.

19. Work sheet

20. Gross profit Mark-up & Margin
Can be either a fraction or a percentage
Mark-up =
Cost price
Gross profit
Can be either a fraction or a percentage
Margin =
Selling price

21. Gross profit Mark-up & Margin
Inventory – 1/1/
Inventory – 31/12/
Purchases 5,200
A mark-up rate of 20% is applied for sales
Find the gross profit and sales revenue figures
You know:
COGS + GP = Sales
COGS +% mark-up = Sales
SO....
20% of 5,000 = 1,000
5, ,000 = 6,000 (sales)
Sales ?
Less COGS:
- Inventory 1/1/
- Add purchases 5,200
Less inventory 31/12/2011 (600)
5000
Gross Profit ?
6,000
SALES
COGS GP
________ +
1,000

22. Gross profit Mark-up & Margin
Inventory – 1/1/
Inventory – 31/12/
Sales 6,400
A mark-up rate of 25% is applied for sales
Find the gross profit and purchases figures
You know:
COGS + GP = Sales
Sales – GP = COGS
SO....
Sales – 25% = COGS
6,400 – 1,600 = 4,800
Sales 6,400
Less COGS:
- Inventory 1/1/
- Add purchases ?
Less inventory 31/12/
Gross Profit ?
SALES
COGS GP
________ +
5,100
4,800
1,600

23. Gross profit Mark-up & Margin
If the mark-up is known, to find the margin take the numerator to be a numerator of the margin, then plus the denominator plus the numerator for the margin’s denominator.
Margin
Mark-up 1 4 2 11 1
4+1 2
11 + 2 1 5 2 13

24. Gross profit Mark-up & Margin
If the margin is known, to find the margin take the numerator to be a numerator of the margin, then plus the denominator less the numerator for the margin’s denominator.
Mark-up
Margin 1 6 3 13 1
6-1 3
13 - 3 1 5 3 10

25. Gross profit Mark-up & Margin
Find the missing fractions:
Margin
Mark-up
5/12
6/15
7/12
1/4
3/21
1/6
1/9
1/8

26. Manager’s commission
Managers usually get a percentage of the profits as a commission. Assume that profits before the manager’s commission was deducted, amounted to £8,400. The manager was entitled to 5% of the profits. 5% of £8,400 is £420. Therefore the profits remaining would be £7,980.
However 5% of £7,980 is £399.
What you should do is...
% commission
100 + percentage commission
X Profit before commission 5
X 8,400
= £400
The profits remaining are £8,000, and £400 is 5% of £8,000. therefore this is now correct