accounting indicators

Profitability

assessing firm’s capacity + ability to earn profit, assuming all other factors were equal

Tools to assess profitability

Trend, horizontal analysis, vertical analysis, benchmark, indicators, variances

Horizontal analysis

comparing reports from one period to the next, + identifying the increase/decrease in specific items in reports

Benchmark

acceptable standard against which the firms actual performance can be assessed

Vertical analysis

Define Return on Owners Investment

profitability indicator indicates how effectively a business has used the owner’s capital to earn profit

ROI Formula

Net Profit/Average Capital *100

ROI of 14%

ROI of 14% means for every dollar invested, owner has earned 14c profit

Related formula to ROI

Debt Ratio; higher DR means higher ROI

ROI Comparison

previous periods, budgets, similar businesses, similar investments

Define Return on Assets

profitability indicator indicates how effectively a business has used its assets to earn profit

POV of ROI

investors

POV of ROA

manager

Formula of ROA

Net Profit/ Average Total Assets *100

ROA comparisons

businesses of diff sizes; ascertain which used A most effectively, one business over time; noting changes in A to isolate changes in profitability

Related formula to ROA

ROI: will always be higher than ROA as Oe will be lower than total A

DR: higher DR, greater the gap b/w ROI & ROA

Define Assets Turnover

efficiency indicator indicates how productively a business has used its assets to earn revenue

ATO formula

Net Sales/Average Total Assets TIMES

ATO comparison

different similar businesses, same business over time, budgets

Formulas related to ATO

ROA = ATO + NPM

ATO should mean higher ROA, must consider expense control (NPM)

Define Net Profit Margin

firm’s ability to manage its expenses so that they either decrease or, in the case of variable expenses, increase no faster than sales revenue

NPM Formula

Net Profit/Net Sales *100

NPM comparisons

prev periods, similar businesses, budgets

Formulas related to NPM

ROA

Define Gross Profit Margin

assesses adequacy of firm’s average markup on all goods sold during particular period, measures expense control as it relates to inventory + Cost of Goods Sold

GPM formula

Gross Profit/Net Sales *100

Liquidity

ability to meet ST debts as they fall due

Define Working Capital Ratio

assess firm’s ability to meet immediate ST debts by measuring the ratio of CA to CL

WCR formula

Current Assets/Current Liabilities

Interpret WCR of 1.2:1

WCR of 1.2:1 means that business has $1.2 of CA for every $ of CL

What does too high WCR reveal

1. Excess cash in bank likely to earn little interest

2. Excessive inv can create storage cost, inv loss + obsolescence

3. Excessive AR that AR are not paying in time

What can the owner do when CR deemed too high

1. Use cash to repay debt

2. Expand business by purchasing NCA

3. Increase drawings

4. Allow inv levels tot run down before reordering

5. Implement strategies to collect amounts outstanding from AR

What can the owner do when WCR is less than 1:1

1. make a cash contribution,

2. seek additional finance,

3. take out loan for purchase of NCA

Define Quick Asset Ratio

assesses firm’s ability to meet its immediate debts by measuring the ratio of quick assets to quick liabilities

QAR formula

CA (excluding inv + prepaid E)/Current Liabilities

Why does QAR exclude inv + prepaid expenses

Most CA can be liquidated, but these 2 cannot be easily liquidated

Define Cash Flow Cover ratio

measures how well a firm can pay its short term debts using cash from operations

CFC formula

Net Cash Flows from Operating Activities/Average CL

The higher the CFC, it reveals

good liquidity & meeting it’s ST financial obligations

Efficiency

measure how efficiently business uses A to generate R + it’s ability to manage those A

Define Accounts Receivable Turnover

assesses how effectively the firm has manages its Acc R, revealing average number of days it takes a firm to collect cash from Acc R

ARTO formula

Average Accounts Receivable/(Net Credit Sales + GST) *365 DAYS

What does a FAST ARTO show

fewer days to collect cash; quickly + can be used to meet debts

What does a SLOW ARTO show

 cash unavailable to meet debts, liquidity problems

Managing Acc R

• Offer discounts for quick settlement

• Sends invoices promptly so customers are immediately aware of amount owing + repayment date

• Conduct extensive credit checks; proven record of paying on time

• Send reminder notices

• Threaten legal action; last resort as expensive + ends relo w/ customer

Define Inventory Turnover

assesses how effectively the firm has managed it’s inventory holding

ITO formula

Average Inventory/Cost of Goods Sold *365 DAYS

What does a FAST ITO reveal

low days, on average, inv is sold quickly 

→ enhancing firms ability to generate cash from sale of inv + assists liquidity

What does a SLOW ITO reveal

high days, firm is less able to generate sales 

→ less able to generate cash inflows in time to meet debts as they fall due

What’s the acceptable rate of ITO

Depends on nature of inventory; 

1. Susceptible to spoilage

2. Technological obsolescence

Inventory Management

• Minimum + maximum inv levels

• Rotate inventory

• Ensure item is up to date

• Maintain appropriate inv mix

• Promote the sale of complementary goods

• Effective marketing

Define Accounts Payable Turnover

effectiveness of a firm in managing it’s Acc P

How to assess APTO

Relies on suppliers credit terms

Managing Acc P

• Develop strong relo w/ supplier; better prices, credit terms + quality of inv

• Pay w/i but as close as possible to credit terms

• Pay early to earn Discount R

• Check each statement of accounts against Acc P; ensure accuracy + up-to-date to avoid overpayment

Related formulas to APTO

ITO: APTO depends heavily on ability to generate cash from inv

ARTO: for credit sales, APTO depends heavily on ability to collect cash from sales

ITO + ARTO should be less than days for APTO

Stability

reliance on external source of funds, ability of business to meet debts + continue operations in LT

Define Debt Ratio

stability indicator that measures the percentage of a firm’s assets that are financed by liabilities

DR formula

Total Liabilities/Total Assets *100

APTO formula

Average Accounts Payable/(Net Credit Purchases + GST) *365 DAYS

What does a high DR mean

Business that relies heavily on borrowed funds; danger for LT stability

• Risk of not being able to repay debts + interest rates rise for larger borrowed amount

• High DR could also be positive on profitability but business is using someone else’s funds to buy A to earn profit

Related formula to DR

ROI: Returns of a high DR; increases ROI + using someone else’s funds to buy A to earn

Non-financial info

• Customer satisfaction

• Website hits

• No. of repeat sales

• Reasons for sale returns

• Customer complaints

• Staff turnover

• Consumer confidence

• Unemployment rate

• Customer demographics

• Carbon footprint

• Inclusive hiring practices

• Diversity in management

Strategies to improve profitability; earning revenue

1. Change SP

2. Change marketing plan

3. Inventory management

4. Online + instore promotions

Strategies to improve profitability; controlling expenses

1. Inventory management

2. Gain more value from wages incurred w/ training + incentives

3. Manage NCA

4. Research suppliers of expenses for best deal

Difference between vertical and horizontal analysis

Horizontal analysis is w/i the same business

Vertical analysis is comparing w/ different business