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Ratios In Depth Notes

LPC Law Notes > Finance and Capital Markets Notes

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Trends and Ration Analysis A trend is simply a comparison of figures form accounts for different years to see whether a patter is established. For example, the net profit figures for successive years might appear as follows: 2009
PS50,000

Profit Increase

2010 PS75,000

2011 PS90,000

2012 PS100,000

The trend is that profit has increased over the years; however a % calculation of the increase is more revealing: Figure for the later year - figure for the earlier year X 100 = %
Figure for the earlier year
PS75,000 - PS50,000__ x 100 = 50%
PS50,000

ROCE Return on Capital Employe d

Sales to Capital employe d

Gross Profit Margin Percenta ge

The increase for 2010-2011 was 20% and for 2011-2012 was 11%. This shows that although there is growth the rate is decreasing over the years. This can show that a marketing campaign was very successful in the beginning, or that interest for the product is decreasing. Net Profit X 100 Capital Employed The ROCE show the profits being made on the resources available to the business. A Business with a higher percentage is using its capital more efficiently. A business with a ROCE of say, 40% is achieving a return of PS40 of net profit for every PS100 invested, compared with only PS15 for a business with a ROCE of 15%. This is a similar calculation to ROCE. It focuses on how well the business is using its net assets. It is based on the sales produced by the net assets employed in the business. The calculation is: Sales/Turnover Capital employed The more sales a business generates form its capital employed, the more profitable the business is likely to be. The higher the figure the better. It relates to the value of sales made to the gross profit made on them, the so-called "profit margin".

___Gross Profit__ x100 =
Sales [or Revenue]
The calculation shows the profit made on each item sold, thus the business is looking to achieve a high percentage figure. A 35% margin means that the business is making 35p per
PS1. Low margins multiplied by high volume turnover can lead to high profits (a business model used by most supermarkets). By contrast, a high profit margin on every PS1 of goods sold will not necessarily lead to high profits if very few items are sold. Liquidity Ratios Liquidity is concerned with whether the business has sufficient funds to pay its creditors on time. Liquidity ratios therefore help to identify whether the business is at risk of insolvency proceedings being initiated by those creditors who have not been paid. Current Is a direct comparison of current assets with current liabilities. I measure the assets which ratio can be turned into cash relatively readily in order to meet liabilities which must be paid within 12 months. The result is expressed as a ratio: __Current assets__ : 1 Current liabilities So if the current assets are PS40,000 and the current liabilities are PS20,000, the current ratio will be :

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