Unit 2 Business Resources
Merit Criteria 3
M3 – Interpret the contents of a trading and profit and loss account and balance sheet
for a selected company, explaining how accounting ratios can be used to monitor the
financial performance of the organisation.
Cont. from P5
Accounting ratios are used to measure how well the business is doing, they are also used to
see how well the business is doing compared to a previous year. Accounting ratios can be
used to determine solvency, profitability and performance.
Solvency – the ability a company has to meet its long term financial obligations
Solvency can be figured out in two ways either using current ratio or acid test ratio, current
ratio is worked out by dividing the business’ current assets by its current liabilities, acid test
ratio is figured out by dividing the stores currents assets (excluding stock) by its current
liabilities, they are both put into a ratio in the same way:
If I was working out solvency using figure 1 from below (using figures from the year of
2014).
To figure out the current ratio I would need the business’s current assets and its current
liabilities which are 50,164 million and 35,442 million respectively,
Using the formula current assets/current liabilities=current ratio
50164/35442 = 1.42 (2dp),
This figure is not yet a ratio and needs to be made into one (it works the same way for both
the current ratio and acid test ratio) it is done by putting the figure you get out of the
equation (in this example 1.42) to 1
The ratio would be 1.42:1 which means Tesco has 1.42 (assets) compared to 1 (liability) this
shows if the business is financially able to meet its liabilities.
The difference between the current ratio and acid test ratio is that the current ratio includes
the stock and the acid test ratio doesn’t so the acid test ratio can be used to see if the
business can meet its current liabilities without needing to sell any stock. It is good practice
to keep the figure that is worked out between 1 and 2 as this will mean that the business is
able to cover its liabilities without too much extra which could be used to invest in the
business to make it better, it is desirable to keep the figure between 1.5 and 2 as this means
they should definitely have enough to cover their liabilities. Below (figure 3) is a graph
showing the current ratio change over time (from 2010-2014)
Profitability – the ability of a business to earn a profit
Gross profit percentage, net profit percentage and return of capital employed are all ways
of calculating profitability. Gross profit percentage and net profit percentage are both used
in similar occasions for example to see how well the company is profiting from selling goods,
return of capital employed is generally used by investors to see whether it is financially
worthwhile to invest in the company (in this case Tesco).
Gross profit percentage is the percentage of money that is made from selling goods or a
Merit Criteria 3
M3 – Interpret the contents of a trading and profit and loss account and balance sheet
for a selected company, explaining how accounting ratios can be used to monitor the
financial performance of the organisation.
Cont. from P5
Accounting ratios are used to measure how well the business is doing, they are also used to
see how well the business is doing compared to a previous year. Accounting ratios can be
used to determine solvency, profitability and performance.
Solvency – the ability a company has to meet its long term financial obligations
Solvency can be figured out in two ways either using current ratio or acid test ratio, current
ratio is worked out by dividing the business’ current assets by its current liabilities, acid test
ratio is figured out by dividing the stores currents assets (excluding stock) by its current
liabilities, they are both put into a ratio in the same way:
If I was working out solvency using figure 1 from below (using figures from the year of
2014).
To figure out the current ratio I would need the business’s current assets and its current
liabilities which are 50,164 million and 35,442 million respectively,
Using the formula current assets/current liabilities=current ratio
50164/35442 = 1.42 (2dp),
This figure is not yet a ratio and needs to be made into one (it works the same way for both
the current ratio and acid test ratio) it is done by putting the figure you get out of the
equation (in this example 1.42) to 1
The ratio would be 1.42:1 which means Tesco has 1.42 (assets) compared to 1 (liability) this
shows if the business is financially able to meet its liabilities.
The difference between the current ratio and acid test ratio is that the current ratio includes
the stock and the acid test ratio doesn’t so the acid test ratio can be used to see if the
business can meet its current liabilities without needing to sell any stock. It is good practice
to keep the figure that is worked out between 1 and 2 as this will mean that the business is
able to cover its liabilities without too much extra which could be used to invest in the
business to make it better, it is desirable to keep the figure between 1.5 and 2 as this means
they should definitely have enough to cover their liabilities. Below (figure 3) is a graph
showing the current ratio change over time (from 2010-2014)
Profitability – the ability of a business to earn a profit
Gross profit percentage, net profit percentage and return of capital employed are all ways
of calculating profitability. Gross profit percentage and net profit percentage are both used
in similar occasions for example to see how well the company is profiting from selling goods,
return of capital employed is generally used by investors to see whether it is financially
worthwhile to invest in the company (in this case Tesco).
Gross profit percentage is the percentage of money that is made from selling goods or a
