Accounting Ratios

S4 Accounting

Profitability Ratios These ratios are calculated

using the Profit & Loss:

Gross Profit as a Percentage of Net SalesNet Profit as a Percentage of Net SalesRate of Stock Turnover

Gross Profit as a Percentage of Net Sales

The GP Percentage is used to calculate what the gross profit is in relation to the sales of a business.

The GP Percentage on turnover is calculated using the formula:Gross Profit x 100

Net Sales (Remember sales - sales returns = net

sales).

Reasons for gross profit DECREASE?

Cash losses: theft or wrong amounts being rung up on the till.

Stock losses: theft of stock by employees or passing of stock to friends.

Expenses: Utilities can increase such as gas and electricity prices.

Mark downs: Reductions in selling price. Damaged or almost out of date goods.

Gross profit to INCREASE.

The gross profit can increase. A rise in the gross profit percentage is almost always due to increased efficiency.

Rate of Stock Turnover

The Rate of Stock Turnover is very important. When a company turns over stock - profit is made.

Stock has turned over when it has been sold and replaced with new stock.

The higher a company turns over stock the greater the profits should be.

Stock Turnover is always expressed as a number followed by the word times.

If your Rate of Stock Turnover is 4 times then the company would have turned the stock over every 3 months.

We calculate the Rate of Stock Turnover with the following formula:Cost of Goods Sold Average Stock ** To calculate Average Stock Opening Stock + Closing Stock

Net Profit as a Percentage of Net Sales

The Net Profit Percentage indicates how well a business has controlled their overheads.

The Net Profit is calculated by deducting the total expenses from the gross profit.

We calculate the Net Profit Percentage of Net Sales with the following formula: Net Profit x 100

Turnover

If there is little difference between the gross and net profit percentages this indicates that the business has been able to control its overheads efficiently.

Balance Sheet Ratios

Return on Capital InvestedWorking (Current) Capital Ratio

Return on Capital Invested

The most important ratio calculated by the owner of a business.

Return on Capital Invested compares profit earned in the year with the capital invested in the business.

A good Return on Capital is essential to any business.

Poor returns on capital should make the owners or partners think whether continuing with the business is a good idea.

To calculate the Return on Capital Invested we use the formula:

Net Profit x 100Capital at Start

Working (Current) Capital Ratio

The Working Capital Ratio or Current Ratio focuses on the relationship between a businesses current assets and current liabilities.

The formula to calculate this ratio is:Current Assets Current Liabilities

A business must never run short of working capital.

This is a very popular cause for business failures.

If a business has a ratio of less than 1:1 then in effect it is insolvent.

Low ratio indicates a lack of working capital.

High ratio indicated there may be too much working capital. Too much money tied up in stock or other assets.