Ratios Calculations and Summarys

Is the Gross Profit as a %age of Sales and used to find out the profitability of a business. Calculated by:

(Gross Profit x 100) DIVIDED BY Sales. The unit is %.

The normal percentage that is considered as reasonable, would be the higher the percentage, the better.

REMEMBER.

• A Gross Profit %age of 5% means that the business makes £5 Gross Profit on every £100 worth of sales.
• A business with a low Gross Profit %age needs a high 'Rate of Stock Turnover' to survive.
• A business with a high Gross Profit %age can survive on a lower 'Rate of Stock Turnover'.

Is the Net Profit as a %age of Sales and used to find out the profitability of a business. Calculated by:

(Net Profit x 100) DIVIDED BY Sales. The unit is %.

Again, the higher the percentage, the better the business did in that particular financial year.

REMEMBER.

• A fall in the net profit %age indicates a rise in expenses relative to sales.
• Increasing expenses without an increase in profit needs investigating.

Is the return on Capital Employed and used to find out the profitability of a business. Calculated by:

(Net Profit x 100) DIVIDED BY Capital Employment*. The unit is %.

The higher the percentage, the better the business has done in that particular financial year.

REMEMBER.

• This ratio represents the 'rate of interest' received on an owner's investment.
• An owner can compare this rate with what they could get if they invested their money elsewhere rather than in their business. E.g. a building society.

*Capital Employment is usually based on closing capital.

Used to calculate the liquidity/solvency (measures ability to pay debts). Calculated by:

Current Assets DIVIDED BY Current Liabilities. The unit is a ratio of (answer):1.

The normal/accepted ratio for the current ratio tends to be 2:1.

REMEMBER.

• 2:1 indicates that you have twice as many current assets as current liabilities. This means you can probably pay off your debts when they're due.
• A figure higher than 2:1 indicates that you have too much liquidity and are not making the best use of your assets.
• Using cash to buy fixed assets would decrease your liquidity.

Used to calculate the Liquidity/Solvency (measures ability to pay debts). Calculated by:

(Current Assets - Stock) DIVIDED BY Current Liabilities. The unit for this is (answer):1.

The normal/accepted ratio for the liquid ratio tends to be 1:1.

REMEMBER.

• As on the previous card, but 1:1 is the accepted normal.
• Any ratios below the normals may mean the business is unable to pay debts.

This calculates the overall performance of a business over a particular financial year. It is calculated by:

Cost of goods sold DIVIDED BY Average Stock. The unit is (answer) times.

Again, the higher the number of times stock is turned over, the better the businesses performance in that year was.

REMEMBER.

• The more times you sell (or turn-over) your stock, the greater your profits will be.
• The longer you keep stock before selling it - the more likely it is to deteriorate (go off) or become obsolete. Therefore reducing profits.
• Businesses with a high ROST can survive on a low Gross Profit %age.
• Businesses with a low ROST need a high Gross Profit %age.