Ratios

• Gross profit Mark-up

  Expresses the profit of the business as a percentage of the amount of capital invested in the business
• Liquid ratio / Acid test

  Current assets - inventory divided by current liabilities
• Profitability Ratios


  1. Gross profit margin calculation: Gross Profit X 100 = % Sales

  2. Profit in relation to revenue calculation: Profit X 100 = Sales

  3. Return on capital employed (ROCE) calculation: Profit X 100 = Capital employed

  4. Expenses in relation to revenue calculation: Expenses X 100 = Sales

  5. Gross profit Mark-up calculation: Gross profit X 100 = Cost of sales
• Profit in relation to revenue


  Measures the percentage of sales made up of net profit
• Gross profit margin


  Measures the percentage of sales made up of gross profit
• Current ratio

  Current assets divided by current liabilities
• Expenses in relation to revenue

  Measures what percentage of sales is taken up by expenses
• A ratio of 1:1 in the acid test is considered ideal
• A ratio of 2:1 in the current ratio is considered ideal
• Return on capital employed (ROCE)

  Measures the profit of the business expressed as a percentage of the amount of capital invested in the business
• Average inventory

  Opening inventory + closing inventory divided by 2
• Inventory turnover


  Measures how long it takes to sell an item of inventory
• Trade payable payment period measures how long it takes for the business to pay Trade payables
• Trade receivable collection period measures how long it takes to receive payment from the Trade Receivables
• Main users of financial ratios

  • The management and the employees
  • Trade payables
  • Potential lenders
  • The community
• Main limitations of ratio analysis

  • Must compare like with like
  • Ratios only present a "snapshot"
  • Ratios only consider financial factors
  • Ratios rely on the quality of the accounts
• Ratio analysis does not provide a complete and exhaustive analysis of a company
• Inventory turnover

  Number of times inventory is sold and replaced over a period
• Inventory


  Goods or materials that a business holds for the ultimate goal of resale