1. Gross Profit Percentage:
This ratio shows how effectively a business has controlled its cost of goods.
The gross profit ratio will change if:
- the selling price of goods changes
- the cost price of goods change
2. Net Profit Percentage:
The ratio shows how effectively the expanses of the business are controlled
The Net Profit ratio will change if:
- the gross profit ratio changes
- expanses change
3. Return on Capital Employed:
This ratio shows the net profit made for each $100 invested by the owner into the business. The higher this percentage the better.
IMPORTANT- often, examiners will take capital employed to mean Average Capital. This means adding the open and closing balance of capital and divide by 2 to get the average. If you are only given the closing Capital, then use this figure.
4. Rate of Stock Turnover:
Average Stock is:
This ratio shows how quickly a business sells its stock. The higher this ratio the better.
5. Current Ratio:
This ratio compares the ability to use current assets to pay the current liabilities.
An ideal ratio is 2:1. A ratio too high means that the business has more current assets than it needs.
6. Acid test(quick) Ratio:
This ratio shows if there is enough cash assets to pay current liabilities. Stock is the least cash- like current asset and so it is subtracted.
An ideal ratio is 1:1.
7. Debtors to Sales Ratio:
This ratio shows how long a business takes to collect money in from its Debtors. The higher the ratio, the worse the business is at getting debtors to pay on time and the more likely it is to have a high level of bad debts and case problems.
8. Creditors to Purchases Ratio:
The ratio shows how long a business takes to pay its creditors. Taking too long to pay creditors is not a good thing as discounts for early payment are lost or suppliers could refuse to supply goods to the business on credit.
9. Return on Equity:
The ratio measures the return earned on the money provided buy the ordinary Shareholders. The higher this answer is better. The ROE should be compared to previous years in order to see if the trend is on the increase or decrease.
10. Earnings per Share:
This ratio calculates how much of the profits are attributable to each ordinary share bought in the company. The higher this figure is the more happy Ordinary shareholders will be.
11. Dividend Yield:
Shareholders pay the market price for shares. This ratio shows the return (dividend) each shareholder receives as a percentage of the price paid for the share. The higher this figure the better. Shareholders will usually calculate this ratio for several companies they are thinking of buying shares in, to see which will pay the highest dividend compared to the market price paid for the share.
Limitations of Ratios
- Results do not explain the results but merely show which areas of the business need further investigation.
- Ratios do not take seasonal factors into account.
- For ratios to be accurate, the information must be timely to be of use- information may not be available for a long time after the end of the financial year.
- To be useful, ratios must be accurate – some information may not be shown in the accounts of the business.
