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Ratios
Key Ratio Formulas
| Term | Definition |
|---|---|
| Current Ratio | Current Assets/Current Liabilities |
| Acid Test/Liquid/Quick Ratio | Current Assets – Stock/Current Liabilities |
| Gross Profit Ratio | Gross Profit X 100/Sales |
| Net Profit Ratio (Operating Profit) | Net Profit X 100/Sales |
| End of Year Profit Ratio (Retained Profit Ratio) | Retained Profit x 100/Sales |
| Return on Capital Employed (ROCE) | Net Profit x 100/Capital Employed |
| Creditor Days Ratio (Trade Payables) | Creditors X 365/Credit Purchases (or costs of sales if purchases is not available) |
| Debtor Days (Trade receivables) | Debtors X 365/Credit Sales |
| Stock Turnover (Inventory Turnover) | Average Stock (Opening Stock + Closing Stock/2)/Cost of Sales x 365 |
| Mark Up Ratio | Gross Profit x 100/Cost of Sales |
| What does the Stock Turnover ratio show? | Measures how rapidly the firm sells its stock |
| What does the Debtor Days ratio show? | The average amount of time a firm takes to collect payments from its debtors |
| What does the Creditor Days ratio show? | The amount of time it takes a firm to pay all of its debts to its creditors |
| What businesses have a high stock turnover? | Firms that sell consumer goods (supermarkets) have a high stock turnover/ car dealers have a low stock turnover |
| What will increase stock turnover? | Stock turnover will increase if lean production techniques are adopted e.g. JIT |
| What can be done to improve the debtor days ratio result? | (1) discount for cash payment and (2) discount for prompt payment |
| What do liquidity ratios show? | Liquidity ratios highlight the ability of the firms to convert its assets into cash. |
| What does the Current Ratio show? | The relationship between the current assets and the current liabilities. |
| What is an ideal Current Ratio result? | 1.5 - 2:1 e.g. for every £1 of short term debt a business has £1.50 - £2.00 worth of short term assets to cover the debt |
| What is an ideal Acid Test ratio? | A ratio of 1:1 (i.e. a value of approximately 1 is satisfactory) |
| What does the ROCE show? | It shows a rate of return on the money invested in the organisation |
| How can a firm increase ROCE? | A firm should try to improve their profits or Increase revenue and/or reduce costs |
| What can cause a low ROCE? | Firms could experience a low ROCE if they are trading in a period of recession or low economic growth The ROCE of a firm may be low if a business needs to spend heavily on investment e.g. if new technology |
| What are the advantages of Ratio analysis? | CIM e.g. (C) Compare with previous performance and with competition (I) Identify potential issues (M) Measure Efficiency |
| What are the disadvantages of Ratio analysis? | CHIME e.g. (C) Compare (hard to compare against competition) (H)Historic (I) Identify (It doesn’t identify causes of problems or solutions) (M) Measure of the human element e.g. it does not take into account motivation (E) External factors |
| How can the Acid Test ratio be improved? | The Acid Test ratio may be low because they have too much stock therefore they could use Just In Time or offer stock (goods) at a discount to try and sell more. |
| What does the Mark Up ratio show? | Shows the gross profit as a percentage of cost of sales |
| How can Gross Profit ratio be improved? | Increase Sales/Decrease cost of sales/Use JIT or bulk buy to reduce costs/Cheaper suppliers |
| How can the Net Profit ratio be improved? | Increase Gross profit/reduces expenses e.g. wages/ lower rent/ lower utilities |
Created by:
durquhart1
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