- Created by: Carlie Rusling
- Created on: 15-05-18 17:26
Limitations of Ratio Analysis
Retrospective Nature - Based on previous performance and therefore not necessarily useful for forward projections.
Different accounting policies - business may change its accounting policies from the previous year and therefore makes it more difficult to complete and less comparable.
External factors - ignore external factors, eg state of the economy or natural disaster or recession.
Ratios are most useful when they are used to compare performance against another comparable business and an industry - this information isnt always available and no 2 businesses are fully comparable as they are always differences
Ratios can be very misleading and easily 'massaged' to make the figures look more attractive. For example, many businesses delay payments to trade creditors at the end of the financial year to make the cash balance higher than normal and the creditor days figure higher too. Dont also explain what caused it, eg was it lower selling price or cost of sales.
Ratios dont take into account any non financial factors, product quality, customer service, employee morale, etc
Improving Profitability Ratios
Gross Profit Margin - Increase selling price or Lower cost of sales
Gross Profit Mark Up - Increasee selling price or Lower cost of sales
Overheads to Revenue - Decrease overheads or Increase sales by decreasing selling price
Profit in Relation to Sales -
Return on Capital Employed - All of the above or decrease equity
Improving Liquidity Ratios
Net Current Asset Ratio -
Liquid Captial Ratio/ACID Test - Decrease stock levels or Increase current liabilities
Rate of Inventory Turnover - Increase sales by reducing price - therefore increase quantity sold hence increase Inventory Turnover or Reduce the cost of inventory purchases (CoS) or Reduce inventory levels - reducing re-order levels/or improving the inventory control system
Trade Receiveable Days - Reduce debtor days by offering discounts for quick payment
Trade Payable Days - Increase payable days but negotiaing better terms