Ratio Analysis
Definition:
A technique for analysing the performance of a business, by comparing one piece of accounting
information with another.
Ratio's do not make decisions - they can help the decision make decide what to do.
They should be placed in context - examining ratio on its own = limited value.
Place in context of organisation, history, economic climate + objectives.
Types of Ratios: Main
Performance/Profitability Ratios Return on capital employed (ROCE).
Gross Profit %.
categories:
Net Profit %.
Liquidity Current Ratio/Working Capital Ratio.
Acid test ratio.
Gearing Gearing ratio.
Shareholder Earnings per share (EPS).
Return on Equity (ROE).
Who uses ratios?
Competitors:
Suppliers:
o Wide range of ratios to
o Firms liquidity.
benchmark.
o Can it repay debts e.g. Acid test ratios.
Investors/Potential Investors:
Customers:
o Dividends paid out +
o Interested in how long they + other customers are
share price e.g.
given to pay e.g. debtor collection period.
dividend per share
Employees:
ratio + dividend yield.
o Profitability might affect pay bargaining e.g. return
on capital employed (ROCE) + NP.
Performance/Profitability Ratios:
Three ratios in this category:
1. ROCE.
𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥
a. 𝑅𝑂𝐶𝐸 = 𝑥 100%
𝑇𝐴−𝑇𝐶
b. Return on money invested.
c. Higher the return the better = bigger dividends.
d. ROCE compared with interested offered by a bank but no risk into a bank.
e. Increase ROCE - increase sales or reduce costs.
2. Net (operating) profit % - For every £1 of sale, net profit of x.
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
a. 𝑁𝑃% = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥 100%
b. Varies according to type of business - high NP is preferable.
c. Comparisons of GP + NP = informative. Firm = stable GP but declining NP = failure to control
expenditure.
d. Improvements - higher prices or a reduction in expenses.
3. Gross Profit % - Every £1 spent of sale, x is gross profit.
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
a. 𝐺𝑃 % = 𝑥 100%
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
b. Varies between markets, e.g. GP on fashionable clothes higher than GP on food.
c. Reducing costs will improve this figure.
Definition:
A technique for analysing the performance of a business, by comparing one piece of accounting
information with another.
Ratio's do not make decisions - they can help the decision make decide what to do.
They should be placed in context - examining ratio on its own = limited value.
Place in context of organisation, history, economic climate + objectives.
Types of Ratios: Main
Performance/Profitability Ratios Return on capital employed (ROCE).
Gross Profit %.
categories:
Net Profit %.
Liquidity Current Ratio/Working Capital Ratio.
Acid test ratio.
Gearing Gearing ratio.
Shareholder Earnings per share (EPS).
Return on Equity (ROE).
Who uses ratios?
Competitors:
Suppliers:
o Wide range of ratios to
o Firms liquidity.
benchmark.
o Can it repay debts e.g. Acid test ratios.
Investors/Potential Investors:
Customers:
o Dividends paid out +
o Interested in how long they + other customers are
share price e.g.
given to pay e.g. debtor collection period.
dividend per share
Employees:
ratio + dividend yield.
o Profitability might affect pay bargaining e.g. return
on capital employed (ROCE) + NP.
Performance/Profitability Ratios:
Three ratios in this category:
1. ROCE.
𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥
a. 𝑅𝑂𝐶𝐸 = 𝑥 100%
𝑇𝐴−𝑇𝐶
b. Return on money invested.
c. Higher the return the better = bigger dividends.
d. ROCE compared with interested offered by a bank but no risk into a bank.
e. Increase ROCE - increase sales or reduce costs.
2. Net (operating) profit % - For every £1 of sale, net profit of x.
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
a. 𝑁𝑃% = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥 100%
b. Varies according to type of business - high NP is preferable.
c. Comparisons of GP + NP = informative. Firm = stable GP but declining NP = failure to control
expenditure.
d. Improvements - higher prices or a reduction in expenses.
3. Gross Profit % - Every £1 spent of sale, x is gross profit.
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
a. 𝐺𝑃 % = 𝑥 100%
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
b. Varies between markets, e.g. GP on fashionable clothes higher than GP on food.
c. Reducing costs will improve this figure.
