Accounting Ratios

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Accounting Ratios

• S4 Accounting

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RATIO ANALYSIS
Ratio analysis is the process of determining and interpreting numerical relationship based on financial statements. It is the technique of interpretation of financial statements with the help of accounting ratios derived from the balance sheet and profit and loss account.
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Basis Of Comparision
Trend Analysis involves comparison of a firm over a period of time, that is, present ratios are compared with past ratios for the same firm. It indicates the direction of change in the performance improvement, deterioration or constancy over the years.
Interfirm Comparison involves comparing the ratios of a firm with those of others in the same lines of business or for the industry as a whole. It reflects the firms performance in relation to its competitors.
Comparison with standards or industry average
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Ways To Interpret Accounting Ratios

• Single absolute ratio.
• Group ratio.
• Historical comparision.
• Inter-firm comparision.
• Projected ratios.

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• Profitability Ratios
• These ratios are calculated using the Profit
  Loss
• Gross Profit as a Percentage of Net Sales
• Net Profit as a Percentage of Net Sales
• Rate of Stock Turnover

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Gross Profit as a Percentage of Net Sales

• The GP Percentage is used to calculate what the
  gross profit is in relation to the sales of a
  business.
• The GP Percentage on turnover is calculated using
  the formula
• Gross Profit x 100
• Net Sales
• (Remember sales - sales returns net sales).

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Reasons for gross profit DECREASE?

• Cash losses theft or wrong amounts being rung up
  on the till.
• Stock losses theft of stock by employees or
  passing of stock to friends.
• Expenses Utilities can increase such as gas and
  electricity prices.
• Mark downs Reductions in selling price. Damaged
  or almost out of date goods.

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Gross profit to INCREASE.

• The gross profit can increase. A rise in the
  gross profit percentage is almost always due to
  increased efficiency.

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Rate of Stock Turnover

• The Rate of Stock Turnover is very important.
  When a company turns over stock - profit is
  made.
• Stock has turned over when it has been sold and
  replaced with new stock.
• The higher a company turns over stock the greater
  the profits should be.
• Stock Turnover is always expressed as a number
  followed by the word times.

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• If your Rate of Stock Turnover is 4 times then
  the company would have turned the stock over
  every 3 months.
• We calculate the Rate of Stock Turnover with the
  following formula
• Cost of Goods Sold
• Average Stock
• To calculate Average Stock
• Opening Stock Closing Stock

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Net Profit as a Percentage of Net Sales

• The Net Profit Percentage indicates how well a
  business has controlled their overheads.
• The Net Profit is calculated by deducting the
  total expenses from the gross profit.
• We calculate the Net Profit Percentage of Net
  Sales with the following formula
• Net Profit x 100
• Turnover

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• If there is little difference between the gross
  and net profit percentages this indicates that
  the business has been able to control its
  overheads efficiently.

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• Balance Sheet Ratios
• Return on Capital Invested
• Working (Current) Capital Ratio

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Return on Capital Invested

• The most important ratio calculated by the owner
  of a business.
• Return on Capital Invested compares profit earned
  in the year with the capital invested in the
  business.
• A good Return on Capital is essential to any
  business.

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• Poor returns on capital should make the owners or
  partners think whether continuing with the
  business is a good idea.
• To calculate the Return on Capital Invested we
  use the formula
• Net Profit x 100
• Capital at Start

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Working (Current) Capital Ratio

• The Working Capital Ratio or Current Ratio
  focuses on the relationship between a businesses
  current assets and current liabilities.
• The formula to calculate this ratio is
• Current Assets
• Current Liabilities

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• A business must never run short of working
  capital.
• This is a very popular cause for business
  failures.
• If a business has a ratio of less than 11 then
  in effect it is insolvent.
• Low ratio indicates a lack of working capital.
• High ratio indicated there may be too much
  working capital. Too much money tied up in stock
  or other assets.

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Price Earning Ratio
It shows how many times the annual earnings the present shareholders are willing to pay to get a share. This ratio helps investors to know the effect of earnings per share on the market price of the share. This ratio when calculated for several years can be used as term analysis for predicting future price earning ratios and therefore, future stock prices.
Average market price per share Price earning ratio Earning per share
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Earning Per Share
This ratio indicates the earning per equity share. It establishes the relationship between net profit available for equity shareholders and the number of equity shares.
Net profit available for equity share holders Earning per share Number of equity shares