ratio analysis

• What is the main indicator of how well a business is performing?

  Profit
• What is the purpose of accounting ratios?

  • Allow managers and stakeholders to make judgements
  • Assess how efficiently a business is being run
• What does gross profit indicate about a business?

  It indicates how efficient the business is at making and selling its products
• Why is gross profit alone insufficient to judge a business's efficiency?

  Because larger businesses typically have higher gross profit figures than smaller ones
• What is the calculation used to judge the efficiency of a business in terms of gross profit?

  Gross profit margin (GPM)
• How is the gross profit margin (GPM) calculated?

  GPM = (Gross Profit / Sales) × 100
• If a business has a gross profit of £438,700 and sales of £956,500, what is the GPM?


  GPM = $\frac{438700}{956500} \times 100 =$$45.8\%$
• What factors can cause variations in GPM between businesses?

  Internal factors like size and stock control, and external factors like interest rates and industry type
• How does the GPM of a large supermarket chain typically compare to that of a corner shop?

  A large supermarket chain usually has a lower GPM than a corner shop
• Why might a corner shop have a higher GPM than a large supermarket?

  Because it has relatively high expenses in relation to sales
• What is the GPM range for jewellers?

  60–80%
• What does a low GPM indicate about a business's cost of sales?

  It may indicate that the costs of sales are high
• What is the formula for calculating net profit margin (NPM)?

  NPM = (Net Profit / Sales) × 100
• If a business has a net profit of £136,500 and sales of £956,500, what is the NPM?

  NPM = $\frac{136500}{956500} \times 100 =$$14.2\%$
• How does the NPM vary compared to the GPM across different industries?

  NPM does not vary by quite as much as GPM across different industries
• What might a low NPM indicate about a newly established business?

  It may indicate high expenses as the business tries to establish itself
• What are the performance bands for judging NPM?

  • NPM of 18%+: Good, indicating effective cost management
  • NPM of 10–17%: Satisfactory, but improvement needed
  • NPM of less than 10%: Poor, indicating opportunities for improvement
• What is an example of a business with a low NPM?

  Walmart, with an NPM below 3%
• What should businesses do if their calculated figures seem low?


  Look for the main causes of poor performance
• Why is it important to compare profitability ratios with other businesses in the same industry?

  • Ensures comparisons are valid
  • Allows for 'like with like' comparisons
  • Helps assess the significance of gross and net profit ratios
• How should profitability ratios be evaluated over time?

  • Compare performance over multiple years
  • Identify patterns for accurate evaluation
  • Avoid relying on a single year's figures