Introduction to accounting-ratio analysis
With a business’s accounting figures we can:
- Compare this year’s profit to the last
- Changes in revenue can be identified
- Differences between one years and the next current assets and liabilities
- Shareholders’ equity
Making these calculations can be good for the business but many problems may also arise:
- You cannot tell exactly about the two businesses performance just by looking at figures
- You cannot tell the profitability of the businesses.
To do exact calculations for this you need to use these two types of ratio:
- Profitability ratios: these include the profit margin ratios which compare the profits of the
business with the sales revenue
- Liquidity ratios: these give a measure of how easily a business could meet its short term debts
Profit margin ratios
- Gross profit ratio is used to compare the gross profit with the sales turnover
Gross profit margin= gross profit/sales revenue x100
- Net profit margin is used to compare the net profit with sales revenue.
Net profit margin= net profit/sales revenue x 100
1. These ratios assess the ability of the firm to pay its short-term debts.
2. They are not concerned with profits, but with the working capital of the business.
3. If there is too little working capital, then the business could become illiquid and be unable to
settle short-term debts.
4. If it has too much money tied up in working capital, then this could be used more effectively and
profitably by investigating in other assets
Liquidity the ability of a firm to pay its short-term debts Current ratio
5. This compares the current assets with the current liabilities of the business
Current ratio= _current assets_
The result can be expressed as a ratio (2:1) or just as a number. No result can be considered as a reliable