Ratio Analysis

Gross Profit Margin=  Gross Profit    

                                  Sales Revenue

• The higher the better
• The level of gross profit varies between markets
• Possible to compare with previous years
• Differences can indicate problems eg; stock, purchases.

Net Profit Margin= Net Profit         

                              Sales Revenue

• The higher the better
• Establishes whether the firm has been efficient in controlling expenses
• Compared with previous years
• ^ GPM may cause lower NPM due to increased costs

Return On Capital Employed

ROCE= Net profit before Interest            

             (Total Assets- Current Liabilities)

• The higher the vaue of ROCE the better
• Comparisons with past years and other companies
• Firms ROCE can be compared with percentage return offered by interest bearing bank accounts to access if money wuld be better off invested in the bank
• There is no right level but most businesses regard 20% as satisfactory

The ROCE can be improved by;

• Increasing the level of profit geerated by the same level of capital invested
• Maintaining the profit but decrease the capital invested

 Current Ratio

Current Ratio= Current Assets: Current Liabilities

• A common benchmark is between 1.5:1 and 2:1, twice as much funds as debts.
• Operating below 1.5:1 would indicate bus does not have enough working capital to cover debts, so the bus may overtrade or over borrowing.
• Operating above 2:1 suggest too much money tied up unproductively.
• Operating below a ratio 1:1 sugest that the bus is heading for bankruptcy.

CR can be improved by:

• Managing working capital better
• Reduce the amount of money unnecessarily tied up in stock.

Gearing

Gearing= hhhhhhhhhhh Non current liabilities          

                Ordinary shareholders funds + Non current liabilities

• A highly geared business = higher risk (implies)
• A lower geard business = low risk propositions

 50%= highly geared

50%= lowly geared

Benefits of high gearing;                                                       Benefits Of Low Gearing;

• Few shareholders more control                                  Less risk
• cheaper source of finance                                            No need to repay high interest
• interest less than dividends                                          Easier to borrow on loans

Profit On Equity

ROE= (Profit before tax - preference dividend)

           (Ordinary share capital + reserves)

Difference between ROCE and ROE:

ROE considers the amount of profits generated from equity, whereas ROCE is the more comprehensive measure. It takes into consideration shareholders funds and liabilities.

Earnings Per Share

EPS=        Profit after tax     

          No. of ordinary share

The ratio should be as high as possible and should be compared with pevious years.

Advantages

• Assist a user of financial statements understand the financial position.
• It can assist users identify strengths and weaknesses within the business , thus faciliitating decision making.
• Can be used to explain and identify trends in relation to specific areas of performance.
• Enable financial comparisons be undertaken over time between business entities effectively and efficiently.

Disadvantages

• Comparing with past trends or competitors may not give a correct image as the figures may not be easily comparable.
• It gives current and past trends, but not future.
• Impacts of inflation is not properly reflected.
• There is differences in analysts which may treat certain items differently
• Ratios are only as good or bad as the underlying information used to calculate them.