For these ratios to be useful, they should be compared over time to see if there are any trends and also compared between businesses within the same industry (competitors). I shall be using the following ratios Solvency Ratios, Acid Test Ratios, Profitability Ratios, Net profit Ratios, Efficiency Ratios, to illustrate the financial state of Porcella. Solvency Businesses can use ratios to work out their solvency by using the current ratio and acid test ratio. These ratios allow businesses and potential investors to see how well they are able to meet their liabilities.
There's a specialist from your university waiting to help you with that essay.
Tell us what you need to have done now!
order now
A business is considered to be solvent when it can pay its debts as they become due. In day-to-day terms, this means it can pay its suppliers by having enough working capital. There are two key ratios that help the business determine whether their business is showing a solvent position. Current ratio: this ratio shows how many assets a business has compared to liabilities; it shows how easily it would be to pay its creditors the current ratio looks at the relationship between current assets and current liabilities.
These figures are always shown on the balance sheet and the ratio is calculated as follows: Current ratio = current assets ? current liabilities For e. g. the current ratio for the balance sheet is, C. R=C. A/C>L = 10,600/3600 =2. 94= 3 If the figure is just over 1, then the business may be in a difficult position for payment, as it is considered good practise to have a figure between 1. 5 and 2, so that the business can be sure it can pay its liabilities easily. A higher figure than 2 would not be good as the money should be placed elsewhere to improve the business.
So in this case the ration I concluded was 3 which said that the business was making proper use of their assets as they can re-invest some of these assets into other parts of the business if they wish. Liquid Ratio Acid (test ratio, quick ratio) The acid test ratio shows the assets compared to liabilities, like the current ratio, but by taking out the stock figure from the current assets, it shows how well a business can meet its liabilities without having to sell stock. Again, the figure should be higher than 1 but not higher than 2. The acid test ration is calculated as follows:
Liquid ratio = Current assets – Stock Current Liabilities Q. R=C. A-S/C. L =10,600-5000/3,600 =1. 5=2 The result of the quick ratio figure for the above business is 2, which is really a good term and that the business is doing really well, which the business can meet its liability without having to sell stock. Profitability Ratios can also show how profitable a business really is, either as a snapshot or over time. We can put the profit in perspective by looking at various ratios which compare profit as a percentage of sales or assets. Gross profit
One of the most commonly used ratios is the gross profit margin, which looks at gross profit as a percentage of turnovers: This calculation shows gross profit as a percentage of the turnover, sales and any other income that a business get. Gross profit % = gross profit ? turnover x 100 E. g. from the above business account G. P%=G. P/TO*100 =33,000/64,000*100 =51. 56 =52% This means that for every ? 1 of sales the business achieves, profit after taking off the costs of production is 52p and the higher the percentage the greater the profit. Net profit
This calculation takes the idea of profitability one stage further by actually considering the profit as a percentage of turnover after all the other expenses have been taken out. This ratio is similar to the gross profit margin but looks at net profit as a percentage of turnovers. Net profit % = net profit ? turnover x 100 E. g. from the snapshot of Porcella business account: N. P%=N. P/TO*100 =11,600/64,000*100 =18. 12 =18% This ratio provides a good measure of performance, but if the percentage is declining, it makes it difficult to correct.
Efficiency Stock turnover This ratio looks at how quickly you turn over stock into sales, and is another good measure of efficiency: Stock turnover = cost of goods sold ? stock value E. g. from the above account Where first we need to calculate the average stock= opening stock + closing stock/by two
