BUSS3

Formula: Operating Profit / Capital Employed X 100

It shows the total resources that a business has available to it. The higher the % the better. And shows how profitable the company is.

How to improve the ratio: 

• Increase Operating Profit (money earned through operations, doesn't include investment)
• Reduce value of Capital Employed.
• Reduce costs.
• Increase profitable sales.

Limitations:

• The figure needs to be compared with previous years.
• Operating Profit figure may include exceptional items e.g. one off large orders.
• May have large one off costs e.g. the writing off of items.

Formula: Current assets / Current Liabilities 

It shows how many times a business could pay of its debts in the next year, from their current assets. A ratio between 1.7 and 2.0 is perfect.

How to improve this ratio:

• Sell off some stock.
• Reuce time for creditors to pay.
• Re-pay some of your loans.

Limitations:

• It is a Crude ratio as it only measure the quantity of the current assets not the quality.
• Even if the ratio is favourable the firm may be in financial trouble.
• If the company is in finacial trouble, the true value of assets may not be realised.

Formula: Current assets - Stocks / Current Liabilities

It shows how many times a business can pay debts in the next year from their current assets, not including Stocks.

How to improve ratio: 

• Reduce time for debtors to pay.
• Re-pay some of your short term loans/overdrafts.
• Sell some fixed assets.
• Increase share capital.

Limitations:

• Company could have lots of money tied up in inventory that is hard to sell.
• It ignores timings of both cash received and cash paid out.

Formula: long term liabilities / Capital employed X 100

It shows the proportion of capital that is financed through borrowing. A ratio of over 50% is said to high gearing company.

How to improve this ratio:

• Focus on profit. By doing things such as minimising costs.
• Issues shares.
• Retain profits rather than paying dividends to shareholders.

Limitations:

• Acceptable levels of gearing vary from business to business.
• Difficult for investor to establish acceptable level of gearing.
• The higher the gearing the risker the business.
• High gearing ratios means you are paying out interest rather than retaining it in the business.

Formula: Revenue / Net assets

It shows the revenue that the business has made using the assets.

How to improve this ratio:

• Improve revenue.
• Decrease the amount of assets used to produce the products.

Limitations:

• There could be exceptional items in the revenue.
• The assets will depreciate over a given period, changing the asset turnover value.
• Recently purchased items, might not be working to full capacity. Therefore, not generating expected profit.
• Doesn't take into account profitability.

Formula: Cost of Sales / Average stock held

It shows the number of times a year a firm sells the value of their stock.

How to improve this ratio:

• Sell off or dispose off slow moving stocks.
• Introduce lean production to reduce stock holdings.
• Increase time taken to pay credit.
• Increase sales from existing stock levels before buying more stock.

Limitations: 

• Irrelevant for businesses in service sector.
• Difficult to compare with other companies ot in you area.

Formula: Trade payable / cost of sales X 365

It shows the average number of days it takes to pay back pay ables to suppliers.

How to improve this ratio:

• Improve trade credit from suppliers.
• Increase the cost of your sales.

Limitations:

• May lose goodwill from suppliers.
• Legal action can be taken.
• Late payments charges.

Formula: Receivables / Revenue X 365

It shows the average number of days it takes to turn receivables into cash.

How to improve this ratio:

• Offer early payment incentives to customers.
• Use invoice factoring.
• Have good credit control facilities.

Limitations:

• The average time for customers to pay their bills varies.
• Some customers may move elsewhere if competitors offer better terms of credit.

Formula: Total dividend paid / Number of ordinary shares in issue

It shows the dividend earned per share as a percentage of the share price.

How to improve the ratio: 

• Reduce the amount of shares. By buying them back.
• Increase profit.

Limitations:

• You don't know how much the shareholder initially paid for the share.
• There may be one off special one-time dividends.
• If number of shares increase then the ratio changes. 

Formula: Dividend Per Share / Share Price X 100

It shows the short term gain of shareholders.

How to improve the ratio:

• Increasing proportion of profits that are paid out as dividends.
• Increase profits

Limitations:

• If figure is poor it may not interest potential investors.
• If your paying dividends, you don't have the money to invest in other things.
• Paying dividends reduces value of business.

• Ratios's deal with money, they don't adress issues like product quality or custoer service.
• Ratios look at the past not the future.
• Ratios are most useful when they are used to compare performance.
• Financial infomation can be "window dessed" making compaisons unreliable.