,Accounting Ratios
Ratio analysis involves comparing one figure against another to produce a ratio
and interpreting that ratio to assess the strengths and weaknesses of the
business.
Capital owned is the amount owed by a business to the owner of the business
on a certain date. Capital employed is the total funds which are being used in
the business.
Purpose is to measure:
• Profitability
• Liquidity
• Asset utilisation
Formula
ü Mark-up
"#$%% &#$'() ("&)
= ×100%
,$%) -' "$$. /$0. (,$%)/,-"/)
ü Margin
67899 :78;<= (6:)
= ×100%
>?@A9
ü Stock turnover rate
B89= C; 688D >8@D (BC6>)
=
EFA7?GA <HFAH=87I
J
Average inventory = (Opening stock – Closing stock)×
K
ü Average stockholding period
EFA7?GA 9=8LM
= ×12 𝑚𝑜𝑛𝑡ℎ𝑠/ 365 𝑑𝑎𝑦𝑠
B89= C; 688D >8@D
Rate of stock turnover of finished goods may be improved.
Ø Reduce stock levels
Ø Generate more sales activity
Turnover= net sales – sales return
,Profitability ratio: it measure the level of profit generated by a business.
• Return on capital employed (ROCE) – is the primary ratio and measures the
return of a business in relation to the long-term investors funds
• Gross profit as a percentage of sales
• Net profit as a percentage of sales
1. Return on capital employed (ROCE)
[A= :78;<= \ ]H=A7A9=
=
B?^<=?@ A_^@8IAD
Capital employed = owners capital + liability/ FA + CA - CL
[A= :78;<=
=
C`HA7 B?^<=?@
2. Gross profit to sales percentage
67899 :78;<= 6:
= ×100%
>?@A9
3. Net profit to sales percentage
[A= :78;<= [:
= ×100%
>?@A9
Liquidity ratio: it measure the financial stability of a business in the short term
• Current ratio/ working capital ratio – Calculate the number of times that
the current liability are covered by current asset
• Liquidity ratio/ acid test ratio/ quick ratio – shows whether the company
can pay its immediate liabilities from the liquid asset
Current ratio Liquidity ratio
Ba77AH= E99A= (BE) Ba77AH= ?99A=e]HFAH=87I
= :1 = :1
Ba77AH= b<?c<@<=I (Bb) Ba77AH= b<?c<@<=I
Quick ratio is more reliable than current ratio because it does not include
inventory in calculation. The quick ratio shows whether the business would have
any surplus liquid funds if all the current liabilities were paid immediately from
the liquid asset.
, Asset utilisation ratios
• Debtors’ collection period – measure the average number of days the
business takes to collects its debtors.
• Creditors’ collection period – measure the average number of days the
business takes to pay its creditors.
Debtors’ collection period Creditors’ collection period
fAc=879 B7AD<=879
= ×365 𝑑𝑎𝑦𝑠 = ×365 𝑑𝑎𝑦𝑠
B7AD<= >?@A9 B7AD<= :a7Lg?9A9
Debtors collection period Creditors payment period
v Less efficient credit control v Shortage of liquid funds
v Allowing longer credit to v Knock-on effect of debtors taking
encourage sales longer to pay
v Not allowing cash discounts v Suppliers not allowing cash discounts
Problems of inter-firm comparison
v Should compare with a business in the same trade
v Should compare a business of approximately the same size
v Should compare with the business in a same size.
v The business may operate on different accounting policies
Factors affect the inter-firm comparison
Different type of expenses - This affects the expenses and the profit and the
profitability ratios that make comparison difficult. For example one business may
own premises, another may rent premises.
Non-monetary factors – Some items will not appear on the accounting statements
but can influence the profitability and prospects of a business. For example
goodwill, quality of management and etc
Accounting policies – These will affect calculation of the profit and the profitability
ratios and the value of the assets. For example methods of depreciation, methods
of stock valuation.
Advantages of paying the creditors before due date
ü Able to take advantage of cash discount
ü Improve the relationship with the suppliers
Disadvantages of paying the creditors before due date
ü The business is deprived of the use of the money earlier than necessary
Ratio analysis involves comparing one figure against another to produce a ratio
and interpreting that ratio to assess the strengths and weaknesses of the
business.
Capital owned is the amount owed by a business to the owner of the business
on a certain date. Capital employed is the total funds which are being used in
the business.
Purpose is to measure:
• Profitability
• Liquidity
• Asset utilisation
Formula
ü Mark-up
"#$%% &#$'() ("&)
= ×100%
,$%) -' "$$. /$0. (,$%)/,-"/)
ü Margin
67899 :78;<= (6:)
= ×100%
>?@A9
ü Stock turnover rate
B89= C; 688D >8@D (BC6>)
=
EFA7?GA <HFAH=87I
J
Average inventory = (Opening stock – Closing stock)×
K
ü Average stockholding period
EFA7?GA 9=8LM
= ×12 𝑚𝑜𝑛𝑡ℎ𝑠/ 365 𝑑𝑎𝑦𝑠
B89= C; 688D >8@D
Rate of stock turnover of finished goods may be improved.
Ø Reduce stock levels
Ø Generate more sales activity
Turnover= net sales – sales return
,Profitability ratio: it measure the level of profit generated by a business.
• Return on capital employed (ROCE) – is the primary ratio and measures the
return of a business in relation to the long-term investors funds
• Gross profit as a percentage of sales
• Net profit as a percentage of sales
1. Return on capital employed (ROCE)
[A= :78;<= \ ]H=A7A9=
=
B?^<=?@ A_^@8IAD
Capital employed = owners capital + liability/ FA + CA - CL
[A= :78;<=
=
C`HA7 B?^<=?@
2. Gross profit to sales percentage
67899 :78;<= 6:
= ×100%
>?@A9
3. Net profit to sales percentage
[A= :78;<= [:
= ×100%
>?@A9
Liquidity ratio: it measure the financial stability of a business in the short term
• Current ratio/ working capital ratio – Calculate the number of times that
the current liability are covered by current asset
• Liquidity ratio/ acid test ratio/ quick ratio – shows whether the company
can pay its immediate liabilities from the liquid asset
Current ratio Liquidity ratio
Ba77AH= E99A= (BE) Ba77AH= ?99A=e]HFAH=87I
= :1 = :1
Ba77AH= b<?c<@<=I (Bb) Ba77AH= b<?c<@<=I
Quick ratio is more reliable than current ratio because it does not include
inventory in calculation. The quick ratio shows whether the business would have
any surplus liquid funds if all the current liabilities were paid immediately from
the liquid asset.
, Asset utilisation ratios
• Debtors’ collection period – measure the average number of days the
business takes to collects its debtors.
• Creditors’ collection period – measure the average number of days the
business takes to pay its creditors.
Debtors’ collection period Creditors’ collection period
fAc=879 B7AD<=879
= ×365 𝑑𝑎𝑦𝑠 = ×365 𝑑𝑎𝑦𝑠
B7AD<= >?@A9 B7AD<= :a7Lg?9A9
Debtors collection period Creditors payment period
v Less efficient credit control v Shortage of liquid funds
v Allowing longer credit to v Knock-on effect of debtors taking
encourage sales longer to pay
v Not allowing cash discounts v Suppliers not allowing cash discounts
Problems of inter-firm comparison
v Should compare with a business in the same trade
v Should compare a business of approximately the same size
v Should compare with the business in a same size.
v The business may operate on different accounting policies
Factors affect the inter-firm comparison
Different type of expenses - This affects the expenses and the profit and the
profitability ratios that make comparison difficult. For example one business may
own premises, another may rent premises.
Non-monetary factors – Some items will not appear on the accounting statements
but can influence the profitability and prospects of a business. For example
goodwill, quality of management and etc
Accounting policies – These will affect calculation of the profit and the profitability
ratios and the value of the assets. For example methods of depreciation, methods
of stock valuation.
Advantages of paying the creditors before due date
ü Able to take advantage of cash discount
ü Improve the relationship with the suppliers
Disadvantages of paying the creditors before due date
ü The business is deprived of the use of the money earlier than necessary
