The document discusses ratio analysis, which allows businesses to analyze financial reports to inform future decision making. Ratios are presented as percentages or ratios and can assist with decision making, interpreting finances, and assessing profitability, stability, and effectiveness. Specific profitability ratios discussed include gross profit ratio, net profit ratio, and return on equity ratio. Recommendations are provided for improving ratios such as increasing sales, lowering costs of goods sold, minimizing expenses, and ensuring appropriate owner investment levels.
6. Gross Profit Ratio
Indicates the ability of a
business to retain profit Gross Pr ofit
x100
from sales NetSales
Compare result to
industry benchmarks to
determine suitability of
business performance
6
7. Result indicates:
for every $ of sales – indicates the number
of cents retained as gross profit
how effective business is in passing on
increases in COGS to customers
7
8. High result may indicate:
ability of business to cover all expenses
capacity to earn acceptable net profit and
return to owner
Low result may indicate inability to:
meet further expenses
Return acceptable net profit
return satisfactory rate to owner
8
9. Recommendations
Improve sales
Ascertain:
Stock levels - should be high enough to meet
demand
appropriateness of stock to appeal to market
demand for stock held
Appropriateness of selling price
Conduct market research/analysis to assist
with the above.
9
10. Institute policy to lower COGS
Investigate alternative suppliers selling similar
quality products for less
Take advantage of discounts offered to lower
costs
10
11. Net Profit Ratio
Indicates the
effectiveness of
managers to minimise
expenses per dollar of
sales Net Pr ofit
x100
NetSales
Compare result to
industry benchmarks to
determine suitability of
business performance
11
12. Result indicates:
for every $ of sales – number of cents
retained as net profit
how effective business is in minimising
expenses
poor GP ratio will impact on NP ratio
12
13. High result may indicate:
High operating revenue
Low operating expenses
Low result may indicate inability to:
Inappropriate pricing policy
Inadequate sales
Inappropriate stock
expenses too high
13
14. Recommendations
Improve Gross Profit
• as per Gross Profit recommendations
Minimise expenses
• Set budgets for departments
Investigate alternative suppliers to lower costs
As per Gross Profit recommendations
14
15. Rate of Return on Equity
Ratio
Indicates the rate of
return generated by an
entity on investment of
the owner
Net Pr ofit
Aim for a return of, around, Averageowner 'sequity
x100
14% which allows funding
for future growth and a Owner 'sequitybeg
return on investment.
/2
Owner 'sequityend
15
16. High result may indicate:
Efficient operations
business may be under capitalised(owner has not
contributed equity to the optimum level)
Under-capitalisation can be identified when NP
ratio is close to or under industry benchmark yet
ROE is well above industry benchmark
16
17. Low result may indicate:
owner’s money may perform better invested
elsewhere
business may be over capitalised (if owner has
invested over the optimum sum into the business)
Can be identified when NP ratio is close to industry
benchmark yet the ROE result is well below
industry benchmark
management may take little risk therefore
business is cautiously managed
inefficient management making poor decisions,
lack of vision.
17
18. Recommendations
Improve net profit result using previous
recommendations.
Check level of capital invested to ensure
appropriateness for industry.
If under-capitalised owner should consider
investing more funds into the business.
If over-capitalised owner should consider investing
excess funds into alternative investments.
18
