Ratio analysis is a technique commonly used to make better sense of financial data

by humzah2013hotmailcom (student)

Ratio analysis is a technique commonly used to make better sense of financial data and help inform makingfinancial decisions. It is not any use of making the decisions on its own it just alerts the managers to any areas that maybe of concern. Ration analysis does not look at sales revenue or profit in isolation, ratios put these figures into the context by comparing them with similar data. So instead of looking at the total profit generated by the business over a year, ratio analysis might compare this figure to the amount of capital that is available to the business. Ratio analysis can reveal which business is best at generating profit. FormulaFormula With FiguresExplanation Gross Profit MarginGross Profit--------------- x 100 = %Sales 256200----------------- x 100 = 57.7%444000This ratio shows how well a business is trading. Gross profit has to meet expenses and costs to provide a reasonable net profit; this is also used in comparisons. This is considered to be good position for SIGNature to be in.Net Profit MarginNet Profit-------------- x 100 = %Sales 66660----------------- x 100 = 15%444000This show the net profit as a percentage which is essential for a business because a business needs to know if it is able to meet its expenses and the

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main purpose of a business is to make a profit. This show that they keep 15% of the total money that they make so it Is considered to be good for their type/standard of business. Efficiency RatioNet Profit----------------------------- x 100 = %Capital Employed66660-------------- x 100 = 41.8%159660This ratio measures efficiency with the business makes a profit from the amount that is initially invested in the business this also shows if good management decisions are made. Current RatioCurrent Assets-------------------------- x:1Current Liabilities70160------------- = 4.5:115500This ratio measures the ability of a business to pay back short term obligations. The minimum a company should be at is recommended at 1 however anything above 2 means that there is too much finance tied up in the short term assets and it is not effectively used in the business. This should not fall bellow 1.5 however it is SIGNature so there may be concern there. Acid TestCurrent Assets – Stock--------------------------------x:1Current Liabilities 70160 - 12000---------------- = 3.8:115500 This ratio shows the ability for a business to settle short term loans. The calculation of this ration involves what is considered to be the most liquid assets the minimum value of 1 is recommended. SIGNature’s is higher than what is recommended therefore they may experience problems with paying short term loans. Debtors--------------------- x 365 Sales 41000------------------ x 365 = 33.7444000This ratio shows how long debtors are taking to pay back. This is only an average of how long it takes; a high debtor’s period may show that a business is struggling to pay back its invoices on time and could experience potential cash shortage. Creditors Creditors ------------------------ x 365Cost Of Sales15500-------------------- x 365 = 22.1256200This ratio measures how long a business takes to pay its debts. This is the average time it takes to The average time it takes to pay back is usually between 30 – 60 days so therefore SIGNature’s is considered to be healthy for the type of business it is. Stock TurnoverCost of goods sold ---------------------------- X times Average Stock 199800----------------- = 33.3 6000This ratio shows how much stock is just sitting around. Holding a lot of stock is bad for a business and the higher the number the more stock is just sitting around therefore the higher the number the worse situation the business is in the lower the number the better for the business. For SIGNature it is not too bad because 33.3 is not that high but this shows them that they need to reduce ordering levels. The stakeholders that will be interested in Ratio Analysis are: Ratio Analysis are: Suppliers – Who will want to know if the firm has enough cash to pay its bills on time, before offering or extending trade credit?Lenders – Who will want to see evidence that the firm is operating profitably and has the resources to pay back the money borrowedCustomers – Who will be interested in how much time they have to pay for credit salesEmployees – who will be interested in how much time they expect before they have to pay for credit sales?Employees – who will want know the level of profit generated by the firm before wanting better terms and condition, such as pay increases. Competitors - who will want finding out any possible weaknesses in performance that they can use to their advantage. Profitability –This is connected to profit but have different purposes Profit is the difference between revenue and costs. Profitability looks at how successful a business is at generating profit relative to its size. A bigger national business would be considered to have a higher level of capital than a small business but whether it depends on how well it converts its capital sales into profits. Liquidity – The short term financial health of a business can also have a big impact on its on-going success. Liquidity is concerned with the management of a business’s working capital. Current assets are those that can be converted relatively easily into cash, as well as cash itself. These include debtors. Stocks are also liquid because although they have not been bought by customers yet they should generate cash in in the near future. Too much working capital can indicate that a business is not making the most efficient of it resources. Efficiency- it is good for a business to know how well it mange’s its resources with debtors, it creditors and the level of stock held by it. Failing to control these aspects of performance and deal with any problems that arise could well affect the future probability and even the survival of a business. Three of the main ratios to measure efficiency are: Debtor’s payment period – This ratio shows how long it takes customers/debtors to pay back on average, so that’s why it key to measuring a business’s efficiency.Creditors payment period – This ratio shows how long it takes for a company to payback it suppliers/creditors.Rate of stock turnover – This ratio shows how long it takes a business to sell or use it stock