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# BTEC Ratio Analysis

Ratio Analysis
by

## andrew mccabe

on 8 May 2017

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#### Transcript of BTEC Ratio Analysis

Profitability
Gross Profit Margin
Gross profit
Sales turnover
100
Looks at gross profit as a percentage of sales turnover
88% would mean for every £1 of sales, 88p is left as gross profit
If raw materials or wages go up - gross profit goes down
Can be improved by reducing direct cost of sales
Without compromise on quality!
Or could try to increase sales or prices of goods
Net Profit Margin
Net profit
Sales turnover
100
For every £1 made in sales how much is left as net profit
After all expenses are deducted
Too low - need to lower expenses
For example moving premises, cutting staff costs
Gives good view of non-production and non-direct costs such as admin and marketing
Example
Frontier Denim
Sales turnover = £411,529
Gross profit = £269,792
Net profit = £41,246

Gross profit margin
£269,852 / £411,529 x 100 = 65.5%

For every £1 Frontier Denim make in sales, 65p is left as gross profit. A fashion retailer is likely to have reasonably high costs of sales due to the nature of the product. If this was a service industry you might expect the percentage to be higher.

Net profit margin
£41,246 / £411,529 x 100 = 10%

For every £1 Frontier Denim makes in sales, just 10p is left as net profit. A fashion retailer is likely to have reasonably high expenses due to the nature of their business. A retail business with a physical location may have high overheads - premises, heat, light.
Liquidity
Return on Capital Employed
Net profit
Net Assets
100
The best measure of profitability
Can compare to interest rate in bank to see if investment is generating a good return
Shows for every £1 invested in the business (owners' capital or retained profit) what percent is being generated in profit
ROCE of 5% means that for every £1 tied up, 5p is being generated in net profit
Example
Net profit before interest and tax = £41,246
Net assets = £186,682

ROCE = £41,246 / £186,682 x 100 = 22%

This means that for every £1 being used within the business, there is a return of 22p. This is certainly higher than you could expect from a bank.
Frontier Denim
Current Ratio
Current assets
Current liabilities
aka "Working capital ratio"
Expressed as X:1
If firm has current ratio of 2:1 means for every £2 owned in current assets it owes £1 in current liabilities
This would be considered okay
0.5:1 would mean for every 50p owned it owes £1 - so if overdraft & creditors wanted money the firm couldn't cover demands from their current assets
The current ratio should be higher than 1:1
1.5:1 – 2:1 is considered as ideal
A value of below 1.5:1 suggests a liquidity/solvency problem
A current ratio higher than 2:1 may indicate poor management of resources - with capital tied up in stocks, debtors or lying idle in the bank
Example
Current assets = £56,130
Current liabilities = £30,270
Current ratio = £56,130 / £30,270 = 1.85

This means that for every £1 the business owes in short-term debt (current liabilities), it owns £1.85 in current assets.

The business therefore has sufficient liquidity to meet short-term debts.
Acid Test / Liquidity Ratio
Current assets - stock
Current liabilities
Tougher measure of firm's liquidity
Takes stock out of equation
Stock is hard to turn into cash quickly
Expressed as x:1
Good to see how much stock firm is carrying
1:1 seen as ideal
A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it owes – very healthy!
A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash to pay for those liabilities. This might put the firm under pressure but is not in itself the end of the world!
Example
Current assets = £56,130
Stock = £34,294
Current liabilities = £30,270

Acid Test = £56,130 - £34,294 / £30,270
= £21,826 / £30,270 = 0.72

This means that for every £1 the business owes in short-term debts, it only has 72p in liquid assets.
This shows firm is illiquid, as it could not meet its short-term debts if immediate payment needed.
Fashion retailers such as Frontier Denim likely to have large amount of current assets in stock.
How solvent a business is - shows how able to meet short-term debts
Efficiency
How well are stock and finances being controlled by management ?
Debtors' Payment Period
Debtors
Credit sales
365
This measures how long on average it takes for debtors to pay - and is expressed as a number of days
If firm has debtors' payment period of 60 days, then it takes on average 2 months for them to pay on credit
Business with cash-flow problems might try to reduce this time
Varies from firm to firm
Varies with B2B or B2C activities
Size, importance of order also affect how much credit is offered
Example
Debtors = £21,455
Sales = £411,529

Debtors' payment period = £21,445 / £411,529 x 365 = 19 days

This means that on average it takes a customer 19 days to pay for their purchases. A fashion retailer is unlikely to offer long payment terms
Creditors' Payment Period
Creditors
Credit purchases
365
This measures how long it takes a firm to pay for goods and services bought on credit
Expressed as a number of days
30 days means on average one month gap between getting stuff and paying for it
Business with cash-flow problems might want to try and extend their credit with suppliers
Example
Creditors = £17,881
Purchases = £128,129
Creditors' payment period = £17,881 / £128,129 x 365 = 51 days

This means that on average the firm pays its suppliers in 51 days. This may mean that some suppliers offer one month's credit, and others two months.
Rate of Stock Turnover
Average stock
Cost of goods sold
Average stock is calculated like this:
Opening stock + closing stock
2
Measures the average amount of time an item in stock is held by the business
Expressed as a number of days
If a business has a stock turnover of seven - it on average holds each item of stock for one week
Florist or fishmonger would have lower stock turnover than fashion business or car dealer
If it appears high then the firm might have stock going out of date or fashion
Example
Opening stock = £34,993
Closing stock = £21,445
Cost of goods sold = £141,737
Average stock= £34,993 + £21,445 / 2
= £56,438 / 2
= £28,219

Rate of stock turnover = £28,219 / £141,737 x 365 = 73 days

On average the business turns its stock over, or sells its stock every 73 days. This is just over every two months, which is what you would expect a from a fashion retailer with approximately six new lines per year.
Measure of how profitable the firm is
Ratio Analysis
Proffidioldeb
Hylifedd
Effeithlonrwydd
Maint Elw Crynswth
Maint Elw Net
Adenillion ar y Cyfalaf a DDdefnyddiwyd
Enghraifft
Enghraifft
Cymhareb Gyfredol
Prawf Asid / Cymhareb Hylifedd
Enghraifft
Enghraifft
Cyfnod Talu Dyledwyr
Cyfnod Talu Credydwyr
Enghraifft
Enghraifft
Enghraifft
Summary
Proffidioldeb - - - - - - -
Profitabiliy
Hylifedd - - - - - - - - -
Solvency
Effeithlonrwydd - - - - - -
Efficiency
Cymharu - - - - - - - - -
Compare
Crynodeb
Further Information
Full transcript