Ratio Analysis
Financial Documents
End of Business Year
Profit and Loss Account
Summarises the income,
and expenses of a firm.
Balance Sheet
Show a firms assets and
liabilities at one point in time.
Business Ratios
These are ways of measuring a firm’s success.
There are 3 types of Ratio:
• (A) Profit
• (B) Liquidity
• (C) Gearing
Where did all the money go?
Sales
- (less)
Cost of Sales
= Equals
Gross Profit
- (less)
Expenses
= Equals
Net Profit
- (less)
Tax
= Equals
Net Profit after Tax
- (less)
Dividends
= Equals
Retained Profits
Profit Ratios
1. The Gross Profit Ratio
Gross Profit x 100 = ___________%
Sales
This shows a comparison between a firms
turnover and the amount of gross profit it is
making. Generally speaking the higher this
figure is the better it is for a firm.
Profit Ratios
2. Net Profit Ratio
Net Profit x 100 = ___________%
Sales
• This shows the relationship between a firm’s level of
sales and the amount of net profit it makes, after all
costs have been deducted. The higher the ratio, the
more profitable a firm is.
• Different industries can expect different net profit
ratios.
Profit Ratios
3. R.O.C.E. (Return of Capital Employed)
Net Profit
Capital Employed
x 100 = ________%
This ratio is often used by investors. The
higher the outcome, the greater the return
and the more profitable the investment.
Time for You to Do Some Work…
• Answer the following, show your working.
• Billy and Frank both run fast food vans. They have
given you the following information.
Billy
Frank
Sales
£500,000
£320,000
Gross Profit
£390,000
£250,000
Net Profit
£125,000
£99,000
1(a). Calculate the gross profit ratio for both firms.
1(b). Calculate the net profit ratio for both firms.
2. Comment on which business you would like to
invest in, why?
How did you do?
1(a)
Billy
£390,000
£500,000
= 78%
1(b)
Billy
£125,000
£500,000
= 25%
x 100
x 100
Frank
£250,000
£320,000
= 78%
Frank
£99,000
£320,000
= 31%
x 100
x 100
Liquidity Ratios
These look at how easily a firm can pay its
debts. The term liquid refers to things that
can quickly and easily be turned into cash.
Such as…. C_______A ________ and
C_________ Liabilities.
You need to know 2 liquidity ratios for your
exams.
• The Current Ratio
• The Acid Test Ratio
Liquidity Ratios
1. The Current Ratio
Current Assets = ___________:1
Current Liabilities
This shows how often a firms can pay its short term
debts, using its current assets.
If this ratio is less than one, a firm cannot pay all its
short term debts without selling fixed assets.
Liquidity Ratios
2. The Acid Test Ratio
(Current Assets – Stock) =
Current Liabilities
_______:1
A problem with the current ratio is that it assumes a
company can sell all of its stock to pay the bills.
A tougher measure of liquidity is the acid test ratio.
Time for You to Do Some Work…
• Answer the following, show your working.
• Billy and Frank both run fast food vans. They have
given you the following information.
Billy
Frank
Current Assets
£4,000
£5,000
Stock
£2,200
£1,000
Current Liabilities
£3,750
£2,100
1(a). Calculate the current ratio for both firms.
1(b). Calculate the acid test ratio for both firms.
2. If you were a supplier, which business would you
offer trade credit to? Why?
How did you do?
1(a)
Billy
£4,000
£3,750
= 1.06:1
Frank
£5,000
£2,100
= 2.38:1
1(b)
Billy
£4,000 - £2,200
£3,750
= 0.48:1
Frank
£5,000 - £1,000
£2,100
= 1.90:1
Gearing Ratio
1. The Gearing Ratio
(you only need one of these at IGCSE)
Long Term Liabilities
Share Capital
x 100 = _______%
This looks at where the money in a business
has come from. Anything over 100% means
that more money has been invested by the
bank, than the owners. The business is said to
be “highly geared.”
Ratios - Final Points
• Ratios are used to measure the performance of a
firm.
• You will need to learn these 5 by heart. THEY
ALWAYS COME UP
• Ratios are useful when compared to things like,
competitors, past performance or targets.
• In real life they are used by a number of groups
including; investors, owners, managers and creditors.
Stakeholders
“Any person or group that has a direct interest in the
performance or activities of a business.”
Stakeholder
Owners
Employees / Union
Managers
Customers
Government
Local Community
Competitors
Suppliers
Objective
What Ratio / Financial
Information?
Stakeholders
“Any person or group that has a direct interest in the performance
or activities of a business.”
Stakeholder
Objective
Owners
Dividend, Share Price,
Return on Investment
Employees / Union
Wages, Benefits, Stability,
Promotion
Managers
As workers, plus meet
targets, growth, bonuses
Customers
Quality and value
Government
Tax, Laws, Employment and
economic Growth
Local Community
Jobs, pollution, stability
Competitors
Suppliers
Long term profitable
contracts
Possible conflict with…
Who cares?
Different stakeholders will look at ratios for different
reasons.
• Shareholders – ensure their Return on Capital
Employed
• Potential Shareholders – is it a good company to
invest in?
• Government – Taxation, legal requirements
• Unions / Employees – can the company afford to
increase wages? Are their jobs safe?
• Suppliers – Do the have enough working capital to pay
their debts?
• Directors – Are objectives being achieved?
Which ratios are most important for each group? Why?
Ratio Analysis
YES !
NO !
• Does not explain
• Useful for comparing
why?
performance with;
• Effect of inflation
– Past years
• Cannot compare
– Competitors
across industries
• Good results can
• No guarantee of
lead to future
future performance
investment and
growth