Aims of Final Accounts
When interpreting final accounts we must answer the following questions
· How well has the business performed this year?
· Does it match my competitors?
· What will those interested in the business think of our performance?
When we look at a set of accounts, the above questions cannot be answered simply by looking at the balance sheet and profit and loss accounts. To bring a level of understanding to our business that will be useful to key groups, we must calculate exactly how the business has performed, and ideally relate this to previous years figures.
To do this we need access to the final accounts of the business we are investigating.
There are three key areas to consider:
1. Profitability
2. Liquidity
3. Activity
Each of the above can be calculated quite simply through a series of straightforward long divisions and multiplications. Using the formulae below we rapidly discover the final outcome of each ratio. However, a number alone means very little, the key skill is the ability to evaluate the numbers, and whether they reflect well on the business concerned.
We will examine the profitability ratio in depth within this task. Further research and deduction is required from you to determine the meaning of our other key ratios.
· Gross Profit ratio
o Gross Profit/Sales x 100
· Net Profit Ratio
o Net Profit/Sales x 100
· Return on capital Employed
o Net Profit/Capital Employed x 100
Liquidity
· Current ratio (sometimes called working capital ratio)
o Current assets/current liabilities
· Liquid ratio (sometimes called the acid test ratio)
o Current assets excluding stock/Current liabilities
Activity
· Stock Turnover ratio
o Costs of goods sold/average stock
· Debtor Collection Ratio
o Debtors/Credit sales over the period x 52 weeks
· Creditor payment ratio
o Creditors/Credit purchase over period x 52 weeks
For an excellent in depth reference on Ratios look at The Business Tools (http://www.businesstools.org/). These are interactive tools that can analyse a whole set of accounting figures but do bear in mind that they are based upon US accounts. The author tells us that a UK version will be released in the future.
Firstly you must complete the profitability ratio tasks included below. By doing this you should become able to calculate other ratios besides being able to look for trends and discrepancies. In addition, we have provided some examples of reasons for changes in ratios over a period, to help you begin to assess the outcomes in this example.
Bear in mind however, that these are theoretical examples, and any true analysis needs to take place with reference to standard industry norms.
Blank Profitability Ratio Tasks
b.Example figures for Profitability Ratios
all figures are in £000's sterling
We can assume that each company operates in a similar industry.
|
Company |
Year |
Gross Profit |
Sales |
Net Profit |
Capital Employed |
|
a |
00 |
700 |
3,100 |
300 |
1,250 |
|
a |
01 |
785 |
2,185 |
350 |
1,450 |
|
a |
02 |
995 |
3,330 |
420 |
1,550 |
|
b |
00 |
325 |
975 |
120 |
3,650 |
|
b |
01 |
312 |
1,145 |
90 |
2,950 |
|
b |
02 |
270 |
1,070 |
60 |
2,650 |
|
c |
00 |
842 |
5,645 |
530 |
7,560 |
