Ratio analysis is all about comparing one figure to another. Ratio analysis also allows inter-firm and intrafirm comparisons.

Net profit percentage of sales

Net profit is calculated using the following formula:

                                          Net profit          

                                                                 X3

                                       Sales turnover          

This ratio looks at net profit as the percentage of sales turnover. This ratio is often referred to as the net profit margin. If net profit margin falls from one year to the next year or is thought to be too low future fashion may look to reduce its expenses for example by moving to cheaper premises or cutting staff costs. Before future fashion take any action future fashion should consult their accountant so they can identify any figures falling whether it is related to sales cost of goods or expenses as all of these will affect the net profit margin.  

Return on capital employed

Return on capital employed is calculated using the following formula:

                     Net profit before interest and tax

                                                                                  X3

                                 Capital employed                              

           

This ratio shows the percentage future fashion is achieving from the capital being used to generate that return.  Investors will often compare ROCE to the interest rate being offered in a bank or building society to see if their investment is working effectively for them in generating a return.

Liquidity

Liquidity ratios measure how solvent a business is also how able it is to meet short term debts. There are two liquidity ratios known as:

Current ratio

 This is calculated using the following formula:

                                    Current assets      

 

                                    Current liabilities

This ratio shows the amount of current assets in relation to current assets in relation to current liabilities.

Acid test ratio

This is calculated using the following formula:

                                  Current assets-stock

                                  Current liabilities            

The acid test is thought to be tougher measure of a firm’s liquidity. As the above ratio shows the amount of current assets in relation to current liabilities but it does not include stock.

Efficiency

Efficiency ratios are used to assess how well management is controlling key aspects of the business primarily stock and finances.  There are three efficiency ratios which are known as:

Debtors’ payment period

This is calculated using the following formula:

                                          Debtors    

                                                                  X365    

                                          Credit sales              

When you do not know what percentages of sales were made on credit are then it is acceptable to use the sales figure as given the profit and loss account. The ratio measures on average how long it takes for debtors to pays is expressed as a number of days. Debtor’s payment period will vary from firm to firm depending upon the nature and price of items sold and whether the business deals with business to business or business to consumer sales.

Creditors’ payment period  

This is calculated using the following formula:

                                             Creditors        

                                                                             X365

                                             Credit purchases            

When you do not know what percentages of purchases were made on credit then it is acceptable to use the purchases figure as given in the profit and loss account. The ratio measures on average how long it tasks a firm to pay for goods and services bought on credit.

Rate of stock turnover

This is calculated using the following formula:

                                          Average stock

                                                                            X356

                                         Costs of goods sold        

The ratio measures the average amount of time an item of stock is held by a business and is expressed as number of days.