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  2.  
  3. CCEA
  4.  
  5. Business Studies
  6.  
  7. Unit A2 1 - Making Business Decisions

Lecture notes

Ratio Analysis
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Definition of what is ratio analysis. Types of ratios. Who uses ratios? Performaance ratios i.e. ROCE, Net Profit or Gross Profit. Liquidity Ratios o.e. Current Ratio or Acid Test Ratio. Gearing ratio. Shareholder Ratios. How to evaluate a company's ratios.

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  • June 30, 2016
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  • 2014/2015
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Ratio Analysis

Definition:

 A technique for analysing the performance of a business, by comparing one piece of accounting
information with another.
 Ratio's do not make decisions - they can help the decision make decide what to do.
 They should be placed in context - examining ratio on its own = limited value.
 Place in context of organisation, history, economic climate + objectives.


Types of Ratios: Main
Performance/Profitability Ratios  Return on capital employed (ROCE).
 Gross Profit %.
categories:
 Net Profit %.
Liquidity  Current Ratio/Working Capital Ratio.
 Acid test ratio.
Gearing  Gearing ratio.
Shareholder  Earnings per share (EPS).
 Return on Equity (ROE).

Who uses ratios?
 Competitors:
 Suppliers:
o Wide range of ratios to
o Firms liquidity.
benchmark.
o Can it repay debts e.g. Acid test ratios.
 Investors/Potential Investors:
 Customers:
o Dividends paid out +
o Interested in how long they + other customers are
share price e.g.
given to pay e.g. debtor collection period.
dividend per share
 Employees:
ratio + dividend yield.
o Profitability might affect pay bargaining e.g. return
on capital employed (ROCE) + NP.

Performance/Profitability Ratios:

Three ratios in this category:

1. ROCE.
𝑃𝑟𝑜𝑓𝑖𝑡 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥
a. 𝑅𝑂𝐶𝐸 = 𝑥 100%
𝑇𝐴−𝑇𝐶
b. Return on money invested.
c. Higher the return the better = bigger dividends.
d. ROCE compared with interested offered by a bank but no risk into a bank.
e. Increase ROCE - increase sales or reduce costs.
2. Net (operating) profit % - For every £1 of sale, net profit of x.
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
a. 𝑁𝑃% = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥 100%
b. Varies according to type of business - high NP is preferable.
c. Comparisons of GP + NP = informative. Firm = stable GP but declining NP = failure to control
expenditure.
d. Improvements - higher prices or a reduction in expenses.
3. Gross Profit % - Every £1 spent of sale, x is gross profit.
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
a. 𝐺𝑃 % = 𝑥 100%
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
b. Varies between markets, e.g. GP on fashionable clothes higher than GP on food.
c. Reducing costs will improve this figure.

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