BUSINESS - RATIOS

Gross profit margin

Gross profit/ Revenue x 100

What is the gross profit margin?

Shows how much profit a business makes from selling goods before other expenses (rent and wages)

Do businesses want a high or low gross profit margin?

The higher the margin = the better control of the costs

Mark up

Gross profit / Cost of sales x 100

What is mark up?

How much more the selling price is compared to the cost price - helps sets prices

Net profit margin

Net profit/ Revenue x 100

What is net profit margin?

Shows how much profit is left after all expenses (rent, wages, tax)

Return on Capital Employed (ROCE)

Net profit before interest and tax/ Capital employed x 100

What is ROCE?

How efficiently the business uses its capital to make profit

Do businesses want a high or low ROCE?

A high

If ROCE is 10% in 2022, and 25% in 2023. What does this mean for the business?

They are getting a better return - which draws in investors

Current ratio

Current assets / Current liabilities

What is current ratio?

To see if the business can pay short term debts using all current assets

What is the ideal current ratio?

1.5 - 2 : 1

What does the numbers represent? (1.5-2:1)

1.5-2 - represents current assets

1 - represents current liabilities

For every £1.50 worth of current assets, the business has £1 worth of current liabilities

So how do you express your current ratio?

X : 1 (X represents your answer)

Liquid capital ratio

(Current Assets - Inventory) / Current Liabilities

What is liquid capital ratio?

To see if the business can pay short term debts without selling inventory

What is the ideal liquid capital ratio?

1 : 1

What is inventory not included?

As it is much harder to convert stock into cash (rather than the assets, such as debtors and cash)

Is a low liquid capital ratio a good or bad thing?

Bad - can cause concern for investors - as it shows you may struggle to pay debts off

If current ratio or liquid capital ratio is too high, what does this mean?

The busines could be wasting money in the bank - could be using it t grow and invest

Trade receivables days

Trade receivables / Credit sales x 365

What are trade receivables days?

How long customers take to pay

Do businesses want shorter or longer trade receivables days?

Shorter - as this means better cash flow

What is an advantage of having longer trade receivables days?

Allows customers to pay in longer days - this may attract new customers

Trade payables days

Trade payables / Credit purchases x 365

What are trade payables days?

How long the business takes to pay suppliers

Do businesses want shorter or longer trade payables days?

Longer - this means better cash flow

But too long - suppliers can become upset - any reduce time (eg. 90 days down to 30 days)

If trade payables days changes from '70 days in 2016 to 50 days in 2017', what are the pros and cons?

Pros - keeps the supplier happy, builds trust- may be rewarded with a longer time frame or a discount

Cons - shorter time to pay - less cash sat with us to use in the business

Compared to the industry at 29 days, (2017 at 70 days), what are the pros and cons?

Pros - allowed to pay later - demonstrates trust

Cons - not paying as promptly as competitors

Inventory turnover

Average inventory / Cost of sales x 365

What is inventory turnover?

How quickly stock is sold and replaced

Do businesses want a higher or lower inventory turnover?

Higher - you buy more stock frequently throughout the year

If you do an inventory turnover calculation, and the answer is 73, what does this mean?

On average, every 73 days you are buying stock

If the inventory turnover was 66 days in 2016 and 73 days in 2017, what are the pros and cons?

Pros - fewer deliveries and delivery charges

Cons - buying stock less frequently, needs a larger warehouse - more stock, may get damaged

Compared to the industry (a 90 days), and in 2017 at 73 days, what does this mean, and why is this?

Competitors buy fewer times per year,

Others hold more stock - could be due to smaller stock or doesn’t go out of date (food)

Apart from the calculations that are ratios, what are the others expressed as?

Percentages

How many decimal places is advised for these?

1 decimal place

What are the probability ratios?

• gross profit margin

• net profit margin

• return on capital employed (ROCE)

• mark up

What are the efficiency ratios?

• trade receivables

• trade payables

• inventory turnover

What are the liquidity ratios?

• current ratio

• liquid capital ratio

What are some limitations of ratios?

- human error - figures are incorrect

- don’t take into account inflation

- comparing ratios between businesses of different sizes may be misleading

- ignore customer satisfaction

- don’t consider external factors

- does not show cause and reasoning

- companies can alter data