Profit Increase

A trend is simply a comparison of figures form accounts for different years to see whether a patter is established. For example, the net profit figures for successive years might appear as follows:

2009	2010	2011	2012
50,000	75,000	90,000	100,000

The trend is that profit has increased over the years; however a % calculation of the increase is more revealing:

Figure for the later year – figure for the earlier year X 100 = %

Figure for the earlier year

75,000 - 50,000__ x 100 = 50%

50,000

The increase for 2010-2011 was 20% and for 2011-2012 was 11%. This shows that although there is growth the rate is decreasing over the years. This can show that a marketing campaign was very successful in the beginning, or that interest for the product is decreasing.

ROCE Return on Capital Employed

Net Profit X 100

Capital Employed

The ROCE show the profits being made on the resources available to the business. A Business with a higher percentage is using its capital more efficiently. A business with a ROCE of say, 40% is achieving a return of 40 of net profit for every 100 invested, compared with only 15 for a business with a ROCE of 15%.

Sales to Capital employed

This is a similar calculation to ROCE. It focuses on how well the business is using its net assets. It is based on the sales produced by the net assets employed in the business. The calculation is:

Sales/Turnover

Capital employed

The more sales a business generates form its capital employed, the more profitable the business is likely to be. The higher the figure the better.

Gross Profit Margin Percentage

It relates to the value of sales made to the gross profit made on them, the so-called “profit margin”.

___Gross Profit__ x100 =

Sales [or Revenue]

The calculation shows the profit made on each item sold, thus the business is looking to achieve a high percentage figure. A 35% margin means that the business is making 35p per 1. Low margins multiplied by high volume turnover can lead to high profits (a business model used by most supermarkets). By contrast, a high profit margin on every 1 of goods sold will not necessarily lead to high profits if very few items are sold.

Liquidity Ratios

Liquidity is concerned with whether the business has sufficient funds to pay its creditors on time. Liquidity ratios therefore help to identify whether the business is at risk of insolvency proceedings being initiated by those creditors who have not been paid.

Current ratio

Is a direct comparison of current assets with current liabilities. I measure the assets which can be turned into cash relatively readily in order to meet liabilities which must be paid within 12 months. The result is expressed as a ratio:

__Current assets__ : 1

Current liabilities

So if the current assets are 40,000 and the current liabilities are 20,000, the current ratio will be :

40,000 = 2:1

20,000

A ratio of 1:1 would mean that the business has exactly 1 of current assets with which to meet every 1 of current liabilities. Most business would expect to have a higher ratio, say 1.5:1.

Acid Test

The Current ratio takes into account all of the current assets. Closing stock may not be quickly saleable. The Acid Test is the ratio between current liabilities and current assets excluding stock (or work in progress in a non-trading business). The Acid Test Ratio omits stock from current assets because of the difficulty in converting stock into cash quickly.

Current Assets – Closing Stock : 1

Current Liabilities

Prepayments form the current assets figure are also excluded as these represent amounts already paid by the business, their very nature means that they cannot usually be converted back into cash.

Example
The following is an extract form a balance sheet
Current Assets
Stock	65,000
Debtors	+50,000
Cash	+5,000
	=	120,000
Current Liabilities
Creditors	40,000
Accruals	+10,000
	=	<50,000>
Net Current Assets		70,000
The Acid Test is: 120,000 – 65,000 = 1.1:1 50,000

An acid test of 1:1 means that the business has 1 of readily liquid assets for every 1 of current liabilities. The lower the ratio, the greater the risk of the business being unable to meet its debts as they fall due. However, even a high ratio needs to be considered critically. The business may not be pursuing its debtors rigorously, or may not have written off sufficient bad debts.

Efficiency Ratios

Efficiency ratios assess how efficient the business is at using the assets available to it. AS they also deal with liquidity they are treated as liquidity ratios.

Stock Turnover

This measures how efficient the business is at selling its stock. It is often expressed as a number of days:

Closing stock (inventory) x 365 (i.e. number of days it takes to sell a product)

Cost of Goods Sold

If a business is taking too long to sell, this may be because it is being offered at a too high price or because there is simply no demand. A supermarket should have a short stock turnover period while a dealer in high value art would normally have a high stock turnover.

Average Settlement Period for Debtors

This shows the length of time it takes for debtors to pay. Ha fast can you get your cash back.

Debtors x 365 (i.e. number of days it takes to recover a debt)

Sales

A high number means that the Co.’s:

Collection system is inefficient (hire the Italian mafia (Colombian mafia))
Business is selling too much on credit
Customers are delaying payment due to financial difficulties they may have

Gearing

Gearing is the relationship between the funding which a company derives as...

#10313 - Ratios In Depth - Finance and Capital Markets

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