1. IGCSE Business studies Accounting and finance
Ratio Analysis

2. Calculation and interpretation of the main
ratios from which business performance
may be assessed:
gross profit ratio
net profit ratio
return on capital employed (ROCE)
current ratio
acid test.
make comparisons with previous years and/or with other
business organisations
describe their function in achieving/furthering business
objectives
show an understanding of the financial information they
provide.
(Students will be provided with formulae in the examination
questions.)

3. Profitability ratios - a measure of how much profit its activities generate
Profit Margin – relates profit to turnover (sales revenue)
In general the higher the profit margin the better. A profit margin of 10% means that the firm makes 10p profit for every £1 of goods sold.
Narrow margins – tend to be on products which are high volume, mass market products which are highly competitive
Wide margins – tend to be on products/services that are low volume, high value with relatively high degree of monopoly power

4. Gross Profit: Sales Revenue – costs of goods sold
Gross Profit Margin = x 100
Turnover
Net Profit: Gross profit- expenses/overhead
Net Profit
Net Profit Margin = x 100
Note that a net profit margin over 10% is good, but remember compare to past years and other similar companies.

5. Return on capital employed (ROCE)
A measure of the efficiency of the firm in using its finances to generate profit.
A ROCE of 15% suggests that the firm uses every £1 to generate profits of 15p
Generally – the higher the ratio, the more effective the firm is in using its assets to generate profits.
Profit for the Year
ROCE = x100
Capital employed (in balance sheet)

6. The ROCE will vary between industries
The ROCE will vary between industries. The greater thye risk , the greater the expected ROCE. But ROCE should always be higher than the rate of interest from the bank , or else you would be better off selling the business and putting the money in the bank

7. Liquidity ratios – ability of a business to meet its debts
Look at the ability of a firm to meet its current liabilities.
Careful management of its income and expenditure is important to its cash flow and its ultimate long term survival
More firms fail through cash flow problems than any other reason

8. Working Capital – having sufficient funds at the right time to be able to meet liabilities
Working capital management is crucial to the success of a firm
Working capital = the difference between current assets and current liabilities

9. The Current Ratio – the proportion of assets to liabilities.
=Current assets/current liabilities
A current ratio of 2 means the firm has sufficient liquidity to cover its liabilities twice over
A current ratio of 0.75 would suggest that the firm is unable to meet its liabilities and could be in a weak financial position
A ratio below 1 does not mean the firm will collapse but it will be in a very vulnerable position
Ideally between

10. Acid Test Ratio = (Current Assets - Stocks) / Current Liabilities The Acid Test Ratio gives an indication whether a firm can meet its liabilities without having to dispose of its stocks. It gives a clear and quick indication of the state of the firm’s liquid assets. The reasons why stocks are not included is that they may be difficult to sell/get rid off. (eg the school has stocks of stationary- could we sell exercise books off to meet our current liabilities??) Ideally, the answer should be between 1 and 1.2. A figure less than 1 indicates that the business may experience difficulties in meeting its short-term debts (i.e. a liquidity crisis). An answer of more than 1.2 indicates that the business may be holding cash in an unproductive and unprofitable form, and it may be better used elsewhere.