TOPIC TITLE: Topic 3: Accounts & FinanceLESSON TITLE: Ratio Analysis

COMPETENCY FOCUS:

Key Skills (Numeracy) (L5): You will develop your skills in numeracy through calculating the financial transactions of a business and to interpret financial data shown in company accounts.

SUCCESS CRITERIABy the end of the lesson, you will be able to…

LO1) To identify basic profitability, liquidity and performance ratios (gui)LO2) To calculate basic ratios for a given company’s financial accounts (Reg-Str)LO3) To interpret and analyse the company’s financial performance using the results from basic ratio analysis (Str- Adv).

Basic Ratios

Ratios are used to help businesses to assess their financial performance.

There are three main types of ratio:

• Liquidity (Solvency)• Profitability• Performance (Gearing)

Calculating Ratios

Liquidity Ratios

Current Ratio: Current Assets/Current Liabilities[measured as ….. :1]

Ideal = anywhere between 1.5:1 and 2:1. If less than 1.5 the business does not have enough working capital

Acid Test Ratio: Current Assets – Stocks / Current Liabilities

If less than 1:1 then its current assets do not cover its current liabilities!

Calculating Ratios

Profitability

Net Profit Margin: Net profit before interest and tax / Turnover x 100

Measured as a percentage, the higher the percentage the better as this means they are making more profit!

Return on Capital Employed:

Net profit before interest & tax (EBIT)Capital Employed (incl shareholder funds) x100 = ______(%)

Calculating Ratios

Profitability

Gross Profit Margin:

GROSS PROFIT x 100

SALES REVENUE

This ratio can help businesses to understand how much profit he is making from buying and selling goods.

Calculating Ratios

Performance Ratios

Debtor Days:

Debtors x365 = Total no of days it takes debtors to paySales Revenue

Asset Turnover:

Sales = Asset TurnoverTotal Assets

Calculating Ratios

Performance Ratios

Gearing:

the proportion of assets invested in a business that are financed by long-term borrowing.

Calculating Ratios

How can the gearing ratio be evaluated?

•A business with a gearing ratio of more than 50% is traditionally said to be “highly geared”.•A business with gearing of less than 25% is traditionally described as having “low gearing”•Something between 25% - 50% would be considered normal for a well-established business which is happy to finance its activities using debt.