Ratio Analysis


Profitability ratios show how good a business is at turning its sales and capital into profit.


Profitability Ratios


Gross Profit Margin = (Gross Profit ÷ Sales) × 100/1 Net Profit Margin = (Net Profit ÷ Sales) × 100/1 A high or increased Gross and Net Profit is a positive trend. Improve by sourcing cheaper stock, or raising selling prices. Return on Investment (ROI) = (Net Profit ÷ Capital Employed) × 100/1 (Capital Employed = Issued Share Capital + Long-Term Loan + Reserves) Good trend: As the % rises, the capital invested earns more Improve by increasing net profit by raising sales or cutting costs.


Liquidity Ratios


Shows whether a business can pay its short-term debts as they fall due. Current Ratio = Current Assets : Current Liabilities (ideal about 2:1) Acid Test Ratio = (Current Assets − Closing Stock) : Current Liabilities (ideal about 1:1)


Good trend: at or near the ideal figures. Bad trend: falling below ideal figures, may then struggle to pay short-term debts. Improve by reducing current liabilities, for example by buying fewer goods on credit.


Gearing shows how much of a business’s capital is borrowed (debt) compared with how much is owned by the shareholders (equity).


Gearing = Debt Capital : Equity Capital (below 1:1 lowly geared, above 1:1 highly geared)


Gearing Ratio


(Debt Capital = Long-Term Loan; Equity Capital = Issued Share Capital + Reserves) Good trend: staying or moving below 1:1, less reliant on borrowing Bad trend: rising above 1:1, more reliant on borrowing and more interest to pay Improve: repay some long-term debt, or raise more equity capital


Add any extra notes here:


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STRAND 2 CHAPTER 26: Final accounts


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