P5-perform ratio analysis to measure the profitability, liquidity and efficiency of a given organisation.
M2-analyse the performance of a business using suitable ratios.
D2-evaluate the financial performance and position of a business using ratio analysis.
Ratio Analysis
Ratio analysis involves calculating and interpreting financial data, this allows the business to know how
well the business is performing. It provides useful insights into the businesses financial position, trading
and future prospects.
It is used to indicate how well the business is trading, this can be done by using the figures from the
profit and loss account and the balance sheet, including assets and liabilities. These figures can then be
compared to similar businesses within the market to see how strong the financial position of the
business is. Historical data can be used for a comparison for future prospects, concluding whether the
business is performing better or worse than it previously has.
Solvency Ratios
Solvency ratios measure the solvency of the business, in other words, how quickly/easily a business can
pay it's creditors by generating cash. It also shows whether the business can meet its short term debts,
and if not it would indicate they would need further finance. The solvency ratio can suggest how risky
the financial structure of the business is, if there are more debts than assets it shows the business is
preforming in a risky way and should reduce the risk by improving their debts. With solvency ratios they
need to be compared to historical data as a years data can be misleading.
Current Ratio
This ratio allows SIGNature and potential investors to measure the ability to meet the businesses current
liabilities.
The calculation is as follows: Current Assets/ Current Liabilities
The figures for SIGNature are 70,160/15,500 = 4.5
This shows for every £4.50 of assets, the business owes £1 in current liabilities, suggesting that the
business can afford its debts and the assets are greater than the liabilities.
A healthy ratio would be between 1 and 2.5, if the ratio is above 2.5 then the business isn't making
money on its assets, so the business should consider making investments within some areas of the
business to create growth. A ratio over 2.5 shows that the current assets aren't being utilised, allowing
the business to lose potential profit, which could have long term impacts. For example, renting
machinery when the company has such a high current ratio is allowing the business to increase its
liabilities rather than its assets. Purchasing the machinery would increase the fixed assets within
SIGNature.
A ratio between 1 and 2.5 would have a positive impact on the business as they are in a stable position,
where as their competitors may not be which can lead to SIGNature being stronger within the market. If
the business is able to maintain a healthy ratio the business would be more solvent, allowing investors
and employees to gain a sense of security within the business.
A ratio less than 1 shows the business can't afford the business debts, suggesting the working capital is
poor. With a ratio below 1, the business would need to look into raising further finance to cover it's
short term debts. SIGNature may need to access further finance so it can cover the debts, however this
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