TOPIC 3.5: Accounts Analysis

Ratio analysis is used to:

Analyse financial statements and assess business performance

Gross profit margin is calculated as:

Gross Profit ÷ Revenue × 100

Operating profit margin is calculated as:

Operating Profit ÷ Revenue × 100

Markup is calculated as:

Profit per item ÷ Cost per item × 100

ROCE stands for:

Return on Capital Employed

ROCE is calculated as:

-

Operating Profit ÷ Capital Employed × 100

The current ratio is calculated as:

Current Assets ÷ Current Liabilities

The ideal range for the current ratio is:

1.5:1 to 2:1

The acid test ratio is calculated as:

(Current Assets - Inventory) ÷ Current Liabilities

Why is inventory removed when calculating the acid test ratio?

Because it may not sell quickly

The ideal range for the acid test ratio is:

0.5:1 to 1:1

Liquidity refers to:

The ability to pay short-term debts

Gross profit margin = Gross Profit ÷ ____________________ × 100.

Revenue

Operating profit margin = Operating Profit ÷ ____________________ × 100.

Revenue

Markup = Profit per item ÷ ____________________ per item × 100.

Cost

ROCE = ____________________ Profit ÷ Capital Employed × 100.

Operating

Current ratio = Current Assets ÷ Current ____________________.

Liabilities

Acid test ratio = (Current Assets - ____________________) ÷ Current Liabilities.

Inventory

What is the difference between profitability ratios and liquidity ratios?

Profitability ratios** - Measure how efficiently the business generates profit (Gross profit margin, Operating profit margin, ROCE, Markup)

- Liquidity ratios - Measure the ability to pay short-term debts (Current ratio, Acid test ratio)

Why is liquidity important to a business?

Prevents business failure (insolvency)

- Maintains supplier relationships

- Keeps employees paid

- Enables the business to take opportunities

- Improves credit rating

What is the formula for gross profit margin?

Gross Profit ÷ Revenue × 100

What is the formula for operating profit margin?

Operating Profit ÷ Revenue × 100

What is the formula for markup?

Profit per item ÷ Cost per item × 100

What is the formula for ROCE (Return on Capital Employed)?

Operating Profit ÷ Capital Employed × 100

What is the formula for current ratio?

Current Assets ÷ Current Liabilities
(Ideal range: 1.5:1 to 2:1)

What is the formula for acid test ratio?

Current Assets - Inventory) ÷ Current Liabilities
(Ideal range: 0.5:1 to 1:1)

What is liquidity?

The ability of a business to pay its short-term debts as they fall due.

Why is liquidity important?

• Prevents business failure (insolvency)

• Maintains supplier relationships

• Keeps employees paid

• Enables the business to take opportunities

• Improves credit rating

Gross profit margin = Gross Profit ÷ ____________________ × 100

Revenue

Current ratio = Current Assets ÷ Current ____________________.

Liabilities