Chapter 20: Ratio Analysis

• Gross profit margin

  Gross Profit / Sales Revenue x 100
• Gross profit mark up

  Gross profit / cost of sales x 100
• Profit in relation to revenue

  Profit / revenue x 100
• Expenses in relation to revenue 


  Expenses / revenue x 100
• Return on Capital employed (ROCE) for sole trader

  Profit / Capital employed x 100
• Return on Capital employed (ROCE) for limited company

  Operating profit / capital employed x 100
• Capital employed

  Total equity + Non current liability
• What are the 5 types of profitability ratios

  Gross Profit Margin

  Gross Profit Mark Up

  Profit In relation to revenue

  Expenses in relation to revenue

  Return on capital employed
• Inventory Turnover (per year)


  Cost of sales / average inventory turnover
• Inventory Turnover (in days)


  average inventory turnover / cost of sales x 365
• What are 5 types of liquidity ratios?

  Return on average inventory

  Current Ratio

  Acid Test

  Trade Receivables

  Trade Payables
• Trade Receivables


  Receivables / credit sales x 365
• Trade payables


  Payables / credit purchases x 365
• Gearing


  Non current liability / capital employed x 100
• What is the one capital/financial structure ratio called?

  Gearing
• Ratio Analysis


  is the technique of interpreting the final accounts of businesses in order to assess strengths and weakness. A business needs to be performing well in areas of profitability, liquidity and capital structure
• Limitation 1 on Ratio analysis

  Window Dressing: The financial statements may be window dressed this means showing the financial position of the business in a better or worse way than it actually is resulting in the ratios not accurately reflecting the true performance of the business
• Limitation 2 on Ratio analysis

  Ratio only focuses on numbers: Ratios are calculated from the financial statements which do not show the full picture of the business e.g. the motivation or quality of the staff which may be important in judging business performance
• Limitation 3 on Ratio analysis

  Based on historical data: The financial statements which provide the basis of ratios are based on the historical cost concept and this may not reflect the current position of the business e.g. asset may be overvalued
• Limitation 4 on Ratio analysis

  Industries Difference: Businesses may have different accounting polices which can make it difficult to compare the results. Acceptable or "normal" levels of financial ratios can vary widely across different industries due to the unique characteristics, capital requirements, and operational dynamics of each sector.