These ratios will help out greatly n a business because they help the business to see their ability to use money. Bellow I show how these ratio analyses can be used by business giving actual figures of situation 4 in the assignment brief appendix for Mr Mark Welling. I will also comment on these ratio analyses.
What ratio analysis are used for
Comparing to other businesses
Ratio analysis can be used by an organisation to compare performances against other businesses.
Monitor performance
Keeping records of ratio analysis will benefit the business as they will be able to monitor their financial performances from the previous year to see if they have improved or if they have been worse off. This helps a business greatly because it means that they will be able to see their performance levels and will be aware if they need to improve on anything.;
Find out areas of improvement
As I said above ratio analysis allow businesses to find out areas they need to improve on in order to better their performance.
Trends
Ratios can also be used as a way of monitoring the trends of a business, if any changes have occurred in the performance of the business. For example maybe the business current ratios have been decreased or maybe the gross profit ratio has decreased. Sometimes this happens in a certain time of year.
Carrying out a ratio analysis helps a business to find out any trends that have occurred over the period of time.
Ratios used to asses’ profitability, liquidity and efficiency
Profitability
Gross profit made compared to sales Gross profit for the year / Sales for the year x 100
This formula is used to compare the gross profit to the sales made. For example if a gross profit was equalled to 50% of the sales made then there is £50 profit from every sale made if sales were at £100. This type of costs can be done from one year to the next. The outcome should be a stable figure through out the year. If it changes the business should consider finding out what the reasons are for this change. This shows the amount a business is making from every pound.
Net profit made compared to sales = Net profit /Sales for the year x 100
This is calculated in the exact same way except for the fact that all of the costs are subtracted altogether including VAT and such, and also the receipts will be included. The net profit is divided by the sales made for the year and it is then multiplied by 100 to give you a final outcome. Because the calculation is the same as that of the gross profits it means that if 50% of the sales are made then £50 is the net profit if the sales were at £100.
Return on capital employed = Net profit for the year before interest and tax/Capital employed x 100
This is the amount received back by the people that have invested in the company a.k.a. investors. Different definitions are used by different business accountants for the capital employed.
Liquidity
Current ratios = current assets/current liabilities
This is used to measure the assets available in comparison to liabilities. Finding out this information helps a business to see if they have the available assets to cover their liabilities.
Acid test ratio/liquidity ratio = Current assets-stock/current liabilities
This calculation is the same as the above but the stock figure is deducted. Reason being that it is not always certain how much will be made from the stocks as they will not always be sold on the set time or as planned or expected.
Efficiency
Debtors payment period = debtors / credit sales for the year x 365
This calculation is made to show on average how long it will take for the debtors to pay back the money owed by them to the business, this is measured in days.
Creditors payment period = creditors / credit purchases for the year x 365
This calculation is used by accountants to figure out how long it will take for the business to pay back any of the debts they owe, this is measured in days.
Rate of stock turnover = average stock / cost of goods sold x 365
This calculation is used by accountants to figure out how long it takes for the business to sell the stock held by them. This will be different for different businesses. For example a business that sells fruit and vegetable or perishable products will keep them for a lesser period than a clothes selling shop as their products might be thrown away after some time.
