Unit 2 Exploring Business Activity P6 - ratios
Unit 2: Exploring Business Activity Assignment 3 P6
Return on capital employed (ROCE)
Net Profit / Average capital employed x 100 = % return
This ratio measures the efficiency of capital investments. It is worked out by considering the net profit as a percentage of the capital employed by that business. The reason this ratio is so useful is because it shows the amount of money an investor is receiving back on their capital as a percentage.
Return on Net Assets
Net Profit for year / Net Assets x 100 = % return
Gives a percentage of how much return of net assets the business is getting from its investments.
Gross Profit %
Gross Profit / Sales x 100 = Gross Profit %
This gives the gross profit percentage which is the profit made over a period without taking into account the operating costs or taxation. The higher the gross profit the better. Gross profit percentage is also sometimes called gross profit margin and the calculation shows how well the business is managing its purchases of stock.
This is a preview of the whole essay
Net Profit %
Net Profit / Sales x 100 = Net Profit %
This is the next step from gross profit and subtracts the operating costs and tax to give the net profit, or overall profit. This ratio shows how well the business manages its other expenses, especially when it is compared to the gross profit percentage. If a business has a high gross profit percentage but a low net profit percentage its operating costs (i.e. staff, petrol, rent, insurance and wages) are too high as they are taking too much profit from the business.
Long-term Loans / Capital x 100 = Gearing %
This ratio is measure of financial leverage between the owner’s funds and creditor’s funds.
An organisation is able to pay its expenses as it has money available within the business, solvency ratios help measure this.
Working Capital Ratio (Or Current Ratio)
Current Assets / Current Liabilities = Working Capital Ratio
Working capital ratio measures how much money you have to pay bills and looks at left over cash within the business. This shows how many assets a business has compared to liabilities, in other words how easy it would be for a business to pay its creditors. This figure should be between 1.5 and 2 so that the business can be sure it pays liabilities easily.
Liquid Ratio (Quick Ratio or Acid Test)
(Current Assets – Stock) / Current Liabilities = Liquid Ratio
This ratio shows the assets compared to liabilities like the current ration, but by taking out the stock figure from the current assets it shows how well a business can meet its liabilities without having to sell stock. The figure should be between 1-2.
These ratios look at how productive items are within the business.
Stock / Cost of goods sold x 365 = Stock Turnover in days
This ratio shows how quickly the business has sold its stock; this is a useful way of measuring efficiency. The faster the stock is turned over the more efficient the business is and is more likely doing well. The calculation for stock turnover can be shown in percentage or in days. The lower the number of the days the better.
Debtors / Sales Turnover x 365 = Debtor Days
The debtor’s collect ion period looks at the link between the number of debtors and how long on average it takes the business to collect its debts. The fewer the number of days, the better credit control the business has because it collects what is owed to it more quickly. If information about credit sales is not available the calculation can still be worked out by using the total sales figure.
Creditors / Cost Of Goods Sold x 365 = Creditor Days
Creditor days are similar to debtor days but they look at how long it takes the business to pay their debts. The shorter the time period taken to pay for the debts the better it is for the business.
Sales / Net Assets = Asset Turnover
This ratio looks at the sales as a percentage of the total assets that a business owns. By dividing the sales by the total assets, the business is able to work out how many pounds it earns for every pound invested in total assets.