RATIO ANALYSIS

Purpose is to analyse a set of accounts via: Profitability How much profit the company has made Liquidity How much cash is available

PROFITABILITY
Return On Capital Employed How much profit is generated from the capital invested. The higher the better.

Gross / Net Profit margin How much profit is generated from the sales. The higher the better Asset Turnover How much sales are generated from the capital invested.

LIQUIDITY
Current Ratio Current assets compared with current liabilities. Should be about 3:1. Acid (Quick) test Current assets less stock compared with current liabilities. Should be about 1:1

Stock Turnover How fast our stock is sold. The quicker the better

LIQUIDITY
Debtors days How long it takes for our customers to pay. The shorter the better Creditor days How long it takes for the firm to pay their suppliers. The longer the better as long as credit agreements are not breached.

Current ratio =

Current assets Current liabilities

= 30,500 24,000

= 1.27

Acid test =

Current assets - Stock Current liabilities

= 30,500 14,000 24,000

= 0.69

Stock turnover =

Stock * 365 Cost of sales

= 14,000 * 365 42,000

= 122 days

Debtor days =

Debtors Sales

* 365

= 16,000 * 365 60,000

= 97 days

Creditor days =

Creditors * 365 Cost of sales

= 24,000 * 365 42,000

= 209 days

Gross profit = margin

Gross Profit * 100 Sales

= 18,000 * 100 60,000

= 30%

Net profit = margin

PBIT * 100 Sales

= 2,500 * 100 60,000

= 4.2%

ROCE =

= 2,500 * 100 Profit * 100 Capital + Long term loans 19,000

= 13%

PROFITABILITY
2001 Gross Profit Margin Net Profit Margin ROCE 69% 20% 21% 2002 63% 24% 24%

COMMENTS
Sales have increased by 24%. Gross profit margin has fallen by 6%. Could be lower prices or higher costs. Net profit margin has increased by 4%, reflecting reduced overhead expenses. ROCE rose from 21% to 24%, shows a healthy return.

LIQUIDITY
2001 Current Ratio Liquid Ratio Debtor days Creditor days Stock days 1.4 : 1 1.25 : 1 49 days 51 days 18 days 2002 1.67 : 1 1.42 : 1 41 days 46 days 17 days

COMMENTS
Current and liquid ratio have increased. This is due to a higher stock level and lower bank overdraft. The liquidity position seems to be a strong one. Debtor days have fallen, improving the cash flow of the company. Creditor days have fallen and are lower than the debtor days. This also improves the cash position of the company. The company is in a strong financial position.

WORKINGS Note: Working Capital = Net Current Assets ROCE = 66 / 300 * 100 = 22%

Operating profit margin = 66 / 820 * 100 = 8%

Assets turnover = 820 / 300 = 2.7 times a year Working capital period = 70 / 754 * 365 = 34 days

Room Occupancy = 5900 / (18 * 365) = 90%

Turnover per employee = 820,000 / 20 = 41,000

APPENDIX
Stately Homes PLC
Target

Homely Ltd.
Actual

ROCE
Operating Profit Margin Asset Turnover Working Capital period Room Occupancy Turnover per employee

26%
13% 2 times 20 days 85% 30,000

22%
8% 2.7 times 34 days 90% 41,000

REPORT WRITING
Header : - To: From: Date: Subject:

Introduction Purpose of the report (Why ?)

Body of report Comment on the ratios Link ratios to give more meaning Conclusion Overall strengths and weaknesses

MEMORANDUM
To: Management Accountant, Stately Homes PLC From: Assistant Date: XX March 2007 Subject: Appraisal of Homely Ltd.

Introduction Carried out appraisal of Homely Ltd. using key accounting ratios and comparing them with the targets.

ROCE Homley Ltd. figure of 22% is below the target of 26%. Management action would be needed to improve profit margins or increase asset turnover. Operating profit margin of 8% is well below the target of 13%. Therefore, cost cuts are needed or room rates increased. Asset turnover of Homely Ltd. Is above that of the target. Hence, sales are good even if profits are poor. Working Capital Period of 34 days is almost double the target. In other words, it is taking too long to for debtors to pay. There will need to be a better control over debtors, and a reduction in stock levels.

Percentage room occupancy is 5% above the target. This may be due to lower room rates
Turnover per employee is healthy mainly due to the low room rate.

CONCLUSION:
Homely Ltd. appears to have both strengths linked with turnover, and weaknesses associated with costs and working capital. Management action should concentrate on exploiting the strengths, whilst improving the weaknesses.