5.5 – Analysis of Accounts

• Capital employed: this is shareholders' equity plus non-current liabilities and is the total long-term and permanent capital invested in a business
• Liquidity: the ability of a business to pay back its short-term debts
• Profitability: the measurement of the profit made relative to either that value of sales achieved or the capital invested in the business
• Illiquid: assets are not easily convertible into cash
• (from the income statement and balance sheet)

  
  

  Return on capital employed = (net profit /capital employed)  x 100%

  • compare with previous years or other companies to see if business more efficient or not
  • shows profit earned from capital used in business
• (using the income statement)

  
  

  Net profit margin % = (net profit / revenue) × 100

  • if (N)PM increases then gross profit was higher or expenses lower
  • compare with previous years or other companies
• (from the balance sheet)

  
  

  Acid test ratio = (current assets - inventories current) / current liabilities

  • similar to current ratio but can be slightly <1 and still be able to repay current liabilities as they fall due
• (from the balance sheet)

  
  

  Current ratio = current assets / current liabilities

  • result of 1+ business has sufficient current assets to pay off current liabilities
  • if <1 then illiquid
  • >2 too much working capital
• Uses and users of accounts:

  • Manager: take better decisions, controlling the operations of a business
  • Shareholders, creditors, government : check on company performance
  • Lender: decide whether or not to give the loan
  • Other companies: use comparing performance
• Limitations of accounts:

  • not full details of accounts for external users
  • ratios based on past data
  • accounting data over time affected by inflation
  • different accounting methods used by different companies
• (from the income statement)

  Gross profit margin % = (gross profit / revenue) × 100

  • if GPM increases then either prices were increased or cost of goods are cheaper
  • compare with previous years or other companies