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9 Cards in this Set
- Front
- Back
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Types of ratio |
There are 5 main lenses through which you can view a comoany's performance: - Profitability - Efficiency - Liquidity - Gearing - Investor These groups of ratio depend on the user of the information and what they seek to know etc. |
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What are profitability ratios? |
These are generally the most common group of ratios that people are most likely to be interested in. Looks at is the business making profit. Looks at this in 2 ways : - How good is the profit in relation to the investment made in the business? (Return on Investment) - ROCE AND ROSF. - How good is the profit in relation to the sales made? (Margin) - GPM AND NPM |
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What is ROCE? |
Return On Capital Employed This ratio is significant as it is a fundamental measure of business performance - Expresses the relationship between operating profit and average long term capital invested in the business.
- Looks at the business' ability to generate operating profit from the money that is invested into the business - What is the return out of the organisation for what we have put in?
Formula :
Operating profit (PBIT) / Capital Employed x 100
Operating profit - The profit from a firm's core business operations, excluding deductions of interest and tax.
Capital Employed - The total amount of capital used for the acquisition of profits by a firm or project.
Equity (retained profits and reserves of the business) + long term liabilities
PBIT - Profit Before Interest and Tax |
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What is ROSF? |
Return On Shareholders Funds Similar to the ROCE BUT looks at the business from the shareholders point of view. - Looks at how much profit the business has generated that could be given to shareholders based on what the shareholders have invested into the organisation. - Measures the profit attributable to ordinary shareholders relative to the amount they have invested. Formula : Profit After Tax (PAT) / Shareholders Funds x 100 PAT - Profit After tax us the very final figure in the income statement - whatever is left over there can be attrivuted to the shareholders (given out as dividends). Shareholders Funds - Includes all of the money that the shareholders themselves have invested into the organisation. |
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Interpretation of ROCE/ROSF. |
- Compares the inputs (capital invested) with outputs (operating profit) - These 2 ratios comoare capital invested to outputs - these ratios asses how effectively the business has used its inputs to create outputs.
- Assesses the effectiveness with which funds have been deployed in the accounting period.
- Allows individuals to decide whether the business/shareholder can be getting a better return by investing funds elsewhere - therefore are interested.
- Ideally the ROCE should be higher than the rate of interest... otherwise why not leave the money in the bank? - Why would investors take the risk in investing in your business if the return is lower than what you would receive if you left your money in the bank? Bank is much less risky. - Why would investors take the risk in investing in your business if the return is lower than what you would receive if you left your money in the bank? Bank is much less risky.
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What is GPM? |
Gross Profit Margin
This ratio calculates the business' profitability just relating to their selling activities.
Measure of profitability in buying and selling goods/services before otger expenses - How profitable is the business just in the buying and selling of goods?
Formula :
Gross Profit / Sales x 100
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Interpretation of Gross profit Margin. |
- How much of our salves revenue are we retaining as Gross profit?
- Represents what a company made after paying off its costs of goods sold - Showing how good the business is at controlling its inventory costs.
- THE HIGHER THE BETTER.
- A lower figure could indicate that the inventory (raw material costs) could be high or that the the price of the product is low.
- Companies with a high GPM are more liquid and have more money to spend on indirect expenses.
- If a company's raw material costs start to increase, the GPM will fall unless selling prices are increased. |
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What is OPM? |
Operating Profit Margin
This ratio shows not just the margins earned on sales but also the firm's ability to control its operating costs.
Formula :
Operating costs (PBIT) / Sales × 100
(The Gross Profit) MINUS (All of the indirect admin expenses) - looking at how much sales revenue the business retains after they have paid for all of their expenses not just inventory.
PBIT - Profit Before Interest and Tax |
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Interpretation of Operating Profit Margin. |
- How much of the business' sales revenue they are reataining as operating profit - How much of the sales revenue the business can retain after subtracting all of the indirect costs (ADMIN EXPENSES). - If the business' GPM is remaining stable but their OPM is falling - they must examine their operating costs - If your GPM stays the same every year but you OPM is dropping = It means that thr business isn't controlling their indirect costs appropriately. Operating costs - Delivery costs, Wages, Gas and Electricity etc. - THE HIGHER THE BETTER. - Less than 5% means the company is in a very competitive sector or is doing BADLY. - Variations in OPM over time, usually due to changes in sales mix, selling prices or indirect costs. Working out this ratio can alter the business to any problems they might be having and allows them to correct this if necessary. |
