Upload
others
View
2
Download
0
Embed Size (px)
Citation preview
ACCOUNTING RATIOSGo for Accounting; Third Edition
Pages 229-241
… Preparing the Financial Statements of a business enable us to have a good idea on the performance of a business. However, by simply looking at the ‘Net Profit/Loss’ is not always enough to make sensible management decisions for the future of the business …
1
The owner of a business will surely ask the following questions in case a Profit is registered:
- Could the results be improved?- Is the profit a fair return on the amount of money invested
in the business?- Is the business performing
well in all areas?
2
On the other hand, the owner of a business will surely ask the following questions in case a Loss is registered:
- Why did the business register a loss?- What could be done to reduce this loss?- How is the business
performing when compared toother similar businesses?
3
Accounting ratios and percentages are used to answer the above questions!
4
5
Take a look at the following Financial Statements of Knight Enterprises for the year ended 31st December 2008:
6
Take a look at the following Financial Statements of Knight Enterprises for the year ended 31st December 2008:
7
… The Income Statement of Knight Enterprises shows that the firm has made a Net Profit of €12,000. Although this figure is important, a closer look is to be given into the Financial Statements to extract more useful information …
… Two important calculations can be made
out of the information found in the Financial
Statements …
WORKING CAPITAL & CAPITAL EMPLOYED
8
… It is very important for a business to know if it has enough funds to pay its debts on a day to day basis.
The Working Capital Calculation gives us a clear indication if a business is able to pay its debts on a day to day basis or not.
Working Capital = Current Assets –Current Liabilities
Work out the Working Capital of Knight Enterprises for the year ended 31st December 2008: ______________________________________________________________
______________________________________________________________
9
… Insufficient funds to be able to pay debts on a day to day basis may have the following consequences:
1. The business will lose valuable cash discounts. 2. Delaying in paying debts may result in interests.3. Start losing its business reputation.4. Firm may close down in order to be able to pay its
debts.
10
… Capital Employed has many definitions. At this stage, we shall consider Capital Employed as the amount of money that the owner has invested and the long-term liabilities which provide more funds for the business to operate in the long-run.
Capital Employed= Capital+ Non-Current Liabilities
Work out the Capital Employed of Knight Enterprises for the year ended 31st December 2008: ______________________________________________________________
______________________________________________________________
11
… Now we will consider two sets of accounting ratios. Accounting Ratios are very useful in giving the decision makers of the firm an indication of how the firm is progressing …
LIQUIDITY RATIOS
PROFITABILITY RATIOS
ACCOUNTING RATIOS
Focus on whether the firm is using its assets well and is able to pay the amounts owing as they become due.
Give us information about aspects of how the
firm is running. These ratios will shed light on
how much a firm is being profitable.
6 4
12
… The following are the Accounting Ratios that we shall study in each and every Category:
LIQUIDITY RATIOS
PROFITABILITY RATIOS
ACCOUNTING RATIOS
1. Current Ratio2. Acid Test Ratio3. Rate of Inventory
Turnover4. Capital Ratio5. Trade Receivable
Ratio6. Trade Payables Ratio
1. Return on Capital Employed
2. Mark Up Ratio3. Gross Profit Ratio4. Net Profit Ratio
6 4
13
LIQUIDITY RATIOS1
The Working Capital Ratio/Current Ratio
This ratio indicates the ease with which a business can pay its debts as they fall due from its Current Assets.
Current Ratio = Current AssetsCurrent Liabilities
The ratio should always be at least one to one (1:1) or ideally greater than this!
14
LIQUIDITY RATIOS1
The Working Capital Ratio/Current Ratio
At the end of 31st December 2015, Knight Enterprises had €47,250 Current Assets and €22,500 Current Liabilities.
Current Ratio = Current AssetsCurrent Liabilities
= €47,250€22,500
= 2.1:1
15
LIQUIDITY RATIOS1
The Working Capital Ratio/Current Ratio
Was the Current Ratio’s answer in the seen example, a positive or a negative one?
16
LIQUIDITY RATIOS2
The Acid Test Ratio/Quick Assets Ratio
This test is much more stiff in that it tests whether a business is able to pay its current liabilities out of its current assets without selling any of its inventory.
Acid Test Ratio = Current Assets – Closing StockCurrent Liabilities
17
LIQUIDITY RATIOS2
The Acid Test Ratio/Quick Assets Ratio
At the end of 31st December 2008, Knight Enterprises had Current Assets totalling to €47,250 of which Closing Stock was of €18,000 and
€22,500 Current Liabilities.Current Ratio = Current Assets – Closing Stock
Current Liabilities
= €47,250 – €18,000€22,500
= 1.3:1
18
LIQUIDITY RATIOS2
The Acid Test Ratio/Quick Assets Ratio
Was the Acid Test Ratio’s answer in the seen example, a positive or a negative one?
19
LIQUIDITY RATIOS3
Rate of Inventory Turnover
This ratio shows the number of times in a financial year the inventory is used.
Rate of Inventory Turnover = Cost of SalesAverage Inventory
Note: The Average Inventory is found by adding the Opening Stock and the Closing Stock and dividing by two.
20
LIQUIDITY RATIOS2
Rate of Inventory Turnover
The Cost of Sales shown in the Income Statement of Knight Enterprises shows a figure of €120,000. The business started the financial year with €12,000 stock and ended with €18,000 closing stock.
Rate of Inventory Turnover = Cost of SalesAverage Stock
= €120,000(€12,000+€18,000/2)
= 8 times
21
LIQUIDITY RATIOS3
Rate of Inventory Turnover
Do you think that a showroom furniture will have a higher rate of inventory turnover than a green grocer?
22
LIQUIDITY RATIOS4
Capital Ratio / Rate of Non-Current Liabilities to Capital Employed
This ratio is used to find out whether a business is financed mainly by its owners or whether outside sources of finance are the main providers of money.
Capital Ratio = Non-Current Liabilities x 100%Capital Employed
Note: Capital Employed is found by adding Capital to Non-Current Liabilities
23
LIQUIDITY RATIOS4
Capital Ratio / Ratio of Non-Current Liabilities to Capital Employed
Non-Current Liabilities as at 31st December 2008 amount to €30,000 whilst that Capital as at the same date amount to €122,250.
Capital Ratio = Non-Current Liabilities x 100%Capital Employed
= €30,000(€122,250 + €30,000)
= 19.7%
24
LIQUIDITY RATIOS4
Capital Ratio / Ratio of Non-Current Liabilities to Capital Employed
Long-term loans provided are less than 20% of the total funds invested in Knight Enterprises.
Is this good?
25
LIQUIDITY RATIOS5
Trade Receivables Ratio / Debt Collection Period
This ratio measures the efficiency of a business in collecting the amount of money owed to it by trade receivables.
Debt Collection Period = Trade Receivables x 365 daysNet Sales
Remember that any money tied up outside the business is money that the business cannot use for its own purposes.
26
LIQUIDITY RATIOS5
Trade Receivables Ratio / Debt Collection Period
Trade Receivables of Knight Enterprises amount to €15,000 at the end of 2008. Moreover, the Net Sales figure shown in the Income Statement for the year ended 31st December 2008 amounts to €150,000.
Debt Collection Period = Trade Receivables x 365 daysNet Sales
= €15,000 x 365 days€150,000
= 36.5 days
27
LIQUIDITY RATIOS5
Trade Receivables Ratio / Debt Collection Period
Ideally the time taken by a business’ trade receivable to pay should be as short as possible!
28
LIQUIDITY RATIOS6
Trade Payables Ratio
This ratio calculates how long a business takes to pay its trade payables.
Trade Payables Ratio= Trade Payables x 365 daysPurchases
29
LIQUIDITY RATIOS6
Trade Payables Ratio
Trade Payables of Knight Enterprises amount to €22,500 at the end of 2008. Moreover, the purchases figure shown in the Income Statement for the year ended 31st December 2008 amounts to €126,000.
Trade Payables Ratio = Trade Payables x 365 daysPurchases
= €22,500 x 365 days€126,000
= 65.17 days
30
LIQUIDITY RATIOS6
Trade Payables Ratio
Ideally the time taken by a business to pay its trade payables should be as long as is practical.
31
LIQUIDITY RATIOS6
Trade Payables Ratio
Compare the Debt Collection Period of Knight Enterprises with its Trade Payables Ratio.
What do you comment?
COMPARE
32
PROFITABILITY RATIOS1
Return on Capital Employed (R.O.C.E)
It is of great importance for a business man to know whether he is receiving a fair amount of Net Profit when compared with the money he has invested in the business.
Return on Capital Employed = Net Profit x 100%Capital Employed
A business man may compare the R.O.C.E with, for example, merely leaving his money in a bank deposit account and receiving interests!
33
PROFITABILITY RATIOS1
Return on Capital Employed (R.O.C.E)
The Net Profit registered by Knight Enterprises for the year ended 31st
December 2008 is of €12,000. Capital Employed is found to be €152,250.
R.O.C.E = Net Profit x 100%Capital Employed
= €12,000 x 100%€152,250
= 7.9%
34
LIQUIDITY RATIOS1
Return on Capital Employed (R.O.C.E)
Would have the owner of Knight Enterprises been wiser if he had invested his money in a savings account yielding 3% interests per annum?
35
PROFITABILITY RATIOS2
Mark Up Ratio
This ratio is used to determine the selling price when the cost of goods is known.
Mark Up Ratio = Gross Profit x 100%Cost of Sales
36
PROFITABILITY RATIOS2
Mark Up Ratio
The Gross Profit registered by Knight Enterprises for the year ended 31st
December 2008 is of €30,000 whilst that the Cost of Sales is found to be €120,000.
Mark Up Ratio = Gross Profit x 100%Cost of Sales
= €30,000 x 100%€120,000
= 25%
37
LIQUIDITY RATIOS2
Mark Up Ratio
Imagine that one of the products sold by Knight Enterprises has a Cost Price of €100. Using a 25% mark up, how much will be the selling price of this product?
38
PROFITABILITY RATIOS3
Gross Profit Ratio
This ratio indicates the amount of gross profit made on the amount of Sales.
Gross Profit Ratio = Gross Profit x 100%Sales
The Gross Profit Ratio should be consistently similar from year to year. Businesses operating in the same trade should have similar Gross Profit Ratios too!
39
PROFITABILITY RATIOS3
Gross Profit Ratio / Margin
The Gross Profit registered by Knight Enterprises for the year ended 31st
December 2008 is of €30,000 whilst Net Sales are found to be €150,000.
Gross Profit Ratio = Gross Profit x 100%Net Sales
= €30,000 x 100%€150,000
= 20%
40
PROFITABILITY RATIOS4
Net Profit Ratio
This ratio indicates the amount of net profit made on the amount of Sales.
Net Profit Ratio = Net Profit x 100%Sales
The Net Profit Ratio may not be the same from year to year since the expenses of the business may vary from one year to another.
41
PROFITABILITY RATIOS4
Net Profit Ratio
The Net Profit registered by Knight Enterprises for the year ended 31st
December 2008 is of €12,000 whilst Net Sales are found to be €150,000.
Net Profit Ratio = Net Profit x 100%Net Sales
= €12,000 x 100%€150,000
= 8%