#16624 - Business Accounts - Business Law and Practice

BUSINESS ACCOUNTS

Ratios
Return on Capital Employed [ROCE] Indicated the rate of return on the capital employed in the business. The higher, the better.
$$\frac{Net\ Profit}{Capital\ Employed}\ \times \ 100\%$$	Net Profit: In P&L, net profit = operation profit Partnerships: before deduction of interest Companies: before deduction of interest AND tax
Capital Employed: Total assets less current liabilities
Net Profit Percentage (Net Return on Sales) Gives the net profit margin on sales and is based on the profit figure before interest has been paid.
$$\frac{Net\ Profit}{Sales}\ \times \ 100\%$$	Net Profit: In P&L, net profit = operation profit Partnerships: before deduction of interest Companies: before deduction of interest AND tax
Sales: = turnover
Margins which are above average will imply good management, but if unusually high may indicate the company has a favoured position in the market which may soon be eroded by competition. Low margins may sometimes be deliberately set to increase the company's market share or attract business from its competitors, but low margins will also be an indication of poor management.
Gearing Ratio Analyses the financial structure of the company.
$$\frac{Borrowings}{Capital\ Employed}\ \times \ 100\%$$	Borrowings: In Balance Sheet, = long-term loans (i.e. creditors falling due after 1 year)
Capital Employed: In Balance Sheet, = creditors falling due after 1 year + called up share capital + share premium account
A high geared business has acquired most of its long-term finance by borrowing whereas a low geared business will have most of its long-term finance from its proprietors.
Liquidity Ratios
Current Ratio	Acid Test Preferred measure of the position of a business.
$$\frac{Current\ Assets}{Current\ Liabilities}\ :1$$	Current Assets: Includes stock, debtors, and cash	$$\frac{Liquid\ Assets}{Current\ Liabilites}\ :1$$	Liquid Assets: Current assets excluding stock
Current Liabilities: Balance Sheet, any debts due within the next 12 months (e.g. taxation, trade creditors, dividends payable)	Current Liabilities: Balance Sheet, any debts due within the next 12 months (e.g. taxation, trade creditors, dividends payable)
If the ratio is less than 1:1 this will usually give cause for concern – may signify shortage of working capital.
Earnings per Share (companies only) Primary measure of a company’s performance.
$$\frac{Net\ Profit\ (after\ tax,\ interest\ \&\ preference\ share\ dividend,\ if\ any)}{Number\ of\ Ordinary\ Shares}$$

Return on Capital Employed [ROCE]

Indicated the rate of return on the capital employed in the business. The higher, the better.

$$\frac{Net\ Profit}{Capital\ Employed}\ \times \ 100\%$$

Net Profit:

In P&L, net profit = operation profit
Partnerships: before deduction of interest
Companies: before deduction of interest AND tax

Capital Employed:

Total assets less current liabilities

Net Profit Percentage (Net Return on Sales)

Gives the net profit margin on sales and is based on the profit figure before interest has been paid.

$$\frac{Net\ Profit}{Sales}\ \times \ 100\%$$

Net Profit:

In P&L, net profit = operation profit
Partnerships: before deduction of interest

Companies: before deduction of interest AND tax

Sales:

= turnover

Margins which are above average will imply good management, but if unusually high may indicate the company has a favoured position in the market which may soon be eroded by competition.
Low margins may sometimes be deliberately set to increase the company's market share or attract business from its competitors, but low margins will also be an indication of poor management.

Gearing Ratio

Analyses the financial structure of the company.

$$\frac{Borrowings}{Capital\ Employed}\ \times \ 100\%$$

Borrowings:

In Balance Sheet, = long-term loans (i.e. creditors falling due after 1 year)

Capital Employed:

In Balance Sheet, = creditors falling due after 1 year + called up share capital + share premium account

A high geared business has acquired most of its long-term finance by borrowing whereas a low geared business will have most of its long-term finance from its proprietors.

Liquidity Ratios

Current Ratio

Acid Test

Preferred measure of the position of a business.

$$\frac{Current\ Assets}{Current\ Liabilities}\ :1$$

Current Assets:

Includes stock, debtors, and cash

$$\frac{Liquid\ Assets}{Current\ Liabilites}\ :1$$

Liquid Assets:

Current assets excluding stock

Current Liabilities:

Balance Sheet, any debts due within the next 12 months (e.g. taxation, trade creditors, dividends payable)

Current Liabilities:

Balance Sheet, any debts due within the next 12 months (e.g. taxation, trade creditors, dividends payable)

If the ratio is less than 1:1 this will usually give cause for concern – may signify

shortage of working capital.

Earnings per Share (companies only)

Primary measure of a company’s performance.

$$\frac{Net\ Profit\ (after\ tax,\ interest\ \&\ preference\ share\ dividend,\ if\ any)}{Number\ of\ Ordinary\ Shares}$$

Accounting Entries
	Profit & Loss	Balance Sheet
Expenses	Deducted from the Gross Profit	–
Assets	–	Shown as Fixed and Current Assets
Gross Profit	Sales minus Cost of Goods Sold	–
Net Profit	Gross Profit minus Expenses	–
Retained Profit	Added to Net Profit for the year	Included as Retained Profit Reserve
Liabilities	–	Shown as Current and Long-Term liabilities
Depreciation	Depreciation for relevant accounting period is an Expense	Accumulated depreciation deducted from asset value = NBV of each Fixed Asset
Opening Stock	Added to Purchases of Stock; then Closing Stock subtracted to give Cost of Goods Sold	–
Closing Stock	Used to calculate Cost of Goods Sold	Current Asset

#16624 - Business Accounts - Business Law and Practice

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