Flashcards in Finance- Ratios Deck (13)
What is the purpose of accounting ratios?
They are used as a tool in the decision making process and as an aid to financial interpretation and planning
Name the 3 different accounting ratios
What do ratios allow the business to do?
Several different ratios can be calculated under each of the headings, this allows comparison between different years for the same business to be made, or comparisons with other businesses in the same sector. This is called ratio analysis
What is the use of a profitability ratio?
Shows how profitable the organisation is
What are some general uses of accounting ratios?
Compare current performance with previous years
Compare with similar sized organisations in the same industry
What are some limitations of accounting ratios? (Name 3)
The accounting information used to calculate the ratios is historic
Comparisons with other businesses can be difficult as many business publish only very limited information
Comparisons must be made using the same ratio calculations- many businesses tweak the ratio formulas to suit their own needs
What do profitability ratios show?
The gross profit ratio
Return on equity employed
Profit for the year ratio
What is the gross profit ratio?
This is used to calculate the gross profit as a percentage of sales revenue. Where the percentage is high, it may indicate that the business has a prudent buying policy.
How is gross profit ratio calculated?
____________ X 100%
What is the profit for the year ratio?
This ratio is used to calculate the return on sales when compared to that total costs of the business.
When a low figure is calculated this shows that the companies expenses may be high and should be further investigated
How is the profit for the year ratio calculated?
Profit for the year
__________________ X 100%
What is the return on equity employed?
This ratio measures how well, or badly, a business has utilised the equity that has been invested in it.
This gives a more useful interpretation of performance than simply looking at the profit figure