Topic 6 of 6 · Form 4
Analysis and interpretation
Gross margin = GP ÷ revenue × 100; mark-up = GP ÷ cost of sales × 100; profit margin = profit for the year ÷ revenue × 100; return on capital employed (ROCE) = profit ÷ capital employed × 100.
Notes for this topic 1 file, in order
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Profitability ratios
Gross margin = GP ÷ revenue × 100; mark-up = GP ÷ cost of sales × 100; profit margin = profit for the year ÷ revenue × 100; return on capital employed (ROCE) = profit ÷ capital employed × 100.
Liquidity ratios
Current ratio = current assets ÷ current liabilities; liquid (acid test) ratio = (current assets − inventory) ÷ current liabilities.
Efficiency ratios
Rate of inventory turnover = cost of sales ÷ average inventory; trade receivables turnover (days) = trade receivables ÷ credit sales × 365; trade payables turnover (days) = trade payables ÷ credit purchases × 365.
Worked example: Opening inventory US$7 000; closing inventory US$9 000; cost of sales US$64 000. Find the rate of inventory turnover.
Average inventory = 8 000 → 64 000 ÷ 8 000 = 8 times
Interpretation
Compare with previous years and other businesses; suggest reasons and improvements (e.g. better credit control, reducing expenses, increasing selling prices).
Limitations
Historical figures, different accounting policies, inflation, non-financial factors ignored.
Working capital
Current assets − current liabilities; importance of adequate working capital.
Check yourself
- Current assets US$36 000 (inventory US$12 000); current liabilities US$20 000. Find the current and liquid ratios.
- What does a falling rate of inventory turnover suggest?
- Give one limitation of ratio analysis.
Show answers
- 1.8 : 1 and 1.2 : 1
- Inventory is selling more slowly (possible overstocking or falling demand).
- Any one: uses historical data, ignores non-financial factors, affected by inflation or different policies.
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