ratio analysis

• why are accounting ratios important?

  they allow stakeholders to evaluate how efficiently a business is being run, particularly by examining its profitability.
• what does gross profit indicate?

  measures how efficiently a business produces and sells its products but does not consider expenses
• how is the gross profit margin calculated?

  gross profit margin = (gross profit/ sales revenue) x 100
• what factors influence the interpretation of GPM?

  • internal: stock control & expense management
  • external: industry type and target market
• what does net profit indicate?

  shows overall profitability after accounting for all revenues and expenses
• how is net profit margin calculated?

  NPM = (net profit/ sales revenue) x 100
• what are good benchmarks for NPM?

  • 18%+: indicates excellent cost management
  • 10-17%: satisfactory, with room for improvement
  • below 10%: indicates poor cost and expense management
• how do GPM and NPM differ in significance?

  GPM focuses on production efficiency

  NPM evaluates overall profitability including expense management
• what should be considered when evaluating profitability ratios?

  • compare with similar businesses in the industry
  • analyze trends over several years
  • consider external factors like industry norms and internal efficiency improvements
• how can a business improve its GPM?

  • increasing sales
  • improving production efficiency
  • reducing cost of goods sold
• how can a business improve its NPM?

  • controlling operating expenses
  • improving cost efficiency
• why is a low NPM not always a sign of poor performance?

  it may indicate high initial expenses, such as advertising, in a new business, these costs may lead to a better profitability in the future
• why is it important to evaluate profitability ratios over time?

  a single years data may be misleading, whereas multi-year trends provide a clearer picture of business performance