EBF1323: ACCOUNTING

WEEK 11: FINANCIAL RATIOS

 PREVIOUSLY..
 Partnership
 Profit & Loss Appropriation Account
 Interest on capital
 Interest on drawings
 Partner’s salary
 OUTLINE
1 What is financial ratios
2 Liquidity ratios
3 Profitability ratios
4 Efficiency ratios
5 Shareholder ratios
 1 WHAT IS FINANCIAL
RATIOS
 Ratio shows the mathematical relation
between a quantity or value of one item
with the quantity or value of another
item.
 The relationship can be illustrated in the
form of percentage or ratios.
 2 LIQUIDITY RATIOS
 Explain the ability of a business to meet
its current or short-term obligations
when fall due.
 Business with liquidity problems may
not be able to continue its business.
 Two commonly used ratios are current
ratio & quick ratio.
 2 LIQUIDITY RATIOS
 Current ratio or working capital ratio
measures the margin of safety to the
creditors.
 It indicates how many times current
liabilities (CL) are being covered by
current assets (CA).
 Current ratio = CA/CL
 2 LIQUIDITY RATIOS
 Eg: CA is RM20,000 & CL is RM10,000.
Calculate current ratio.
Current ratio =
This indicates for every RM1.00 of
current liabilities, the business has
RM2.00 of current assets to pay off its
current liabilities.
 So, the higher the ratio, the more liquid
is the business.
 9.2 LIQUIDITY RATIOS
 Quick ratio provides a better measure
of liquidity because items considered to
be least liquid are taken out from CA.
 Quick ratio = CA -stock –prepaid asset
CL
 The higher the ratio, the more liquid te
business.
 3 PROFITABILITY
RATIOS
 Evaluate a business profit performance
during the period.
 Profitable business has a potential to
grow & survive in the long-run.
 There are 3 commonly used ratios,
namely gross profit ratio, net profit
ratio, & return on capital employed.
 3 PROFITABILITY
RATIOS
 Gross profit ratio evaluates the
relationship of gross profit as a
percentage of sales.
 Gross profit ratio = Gross profit X 100
Net Sales
 A gross profit ratio of 30% means for
every RM1 of sales, a gross profit of
RM0.30 is made. So, RM0.70 used to
pay COGS.
 3 PROFITABILITY
RATIOS
 Net profit ratio or net profit margin
evaluates the relationship of net profit
as a percentage of sales.
 Net profit ratio = Net profit X 100
Net Sales
 This ratio measures the profitability
after considering all revenues &
expenses.
 3 PROFITABILITY
RATIOS
 A net profit margin of 10% indicates
that for every RM1 of sales, RM0.10 is
net profit. RM0.90 is used to cover
COGS and other operating expenses.
 4 EFFICIENCY RATIO
 Also known as activity ratio measure
the efficiency of a business in managing
its capital employed.
 Include stock turnover ratio & debtors
turnover ratio.
 Stock turnover ratio measures how
efficient stock is being manage by a
business.
 4 EFFICIENCY RATIO
 Stock turnover ratio = COGS
(times) Average stock

 Average stock = Opening stock + Closing stock

2
 A ratio of 3 times means on average,
stock is being replaced 3 times.
 4 EFFICIENCY RATIO
 The higher stock turnover ratio the
better because it shows the business is
able to sell its goods regularly & new
stock are purchased to replace the
goods sold.
 A low ratio indicates the stock are slow
moving which may cause obsolete
stock, non-selling items or excessive.
 4 EFFICIENCY RATIO
 Debtors turnover ratio measures how
efficient is the business in collecting the
amount owed by debtors by looking at
the length of a time debtor takes to pay
the business.
 9.4 EFFICIENCY RATIO
 Debtor turnover ratio = Debtors
(days) Sales
 Debtors turnover ratio days indicates
number of days from the sales made
until the time the debtors made
payment.
 The lower the ratio, the better - the
shorter time taken by the business to
collect its credit sales.
 EXAMPLES
The following are summarized Financial Statements
of Encik Harun, a retail trader.
Income Statement for the year ended 30.6.2009
RM RM
Sales 130,000
Cost of goods sold
Opening stock 25,000
Add: Purchases 80,000
105,000
Less: Closing stock 25,000 80,000
Gross profit 50,000
Less: Expenses 30,000
Net profit 20,000
 EXAMPLES

Balance Sheet as at 30.6.2009

RM RM
Fixed assets 10,000
Current assets
Stocks 20,000
Debtors 35,000
Bank 15,000
70,000
Current liabilities 14,000 56,000
66,000
Capital 46,000
Add: Net profit 20,000 66,000
 EXAMPLES
You are required to calculate:
a) Gross profit ratio
b) Net profit ratio
c) Stock turnover ratio
d) Current ratio
e) Acid test ratio
 EXAMPLES
a) Debtor turnover ratio = Debtor / Net sales =

b) Net profit ratio = Net profit / Net sales =

c) Stock turnover ratio (time)= COGS / Avg

stock =

d) Current ratio = CA/CL =

e) Acid test ratio = CA – stock /CL =

 SUMMARY
FINANCIAL RATIOS

Liquidity Profitability Efficiency

Current = CA/ CL Gross profit = Stock turnover

Gross ∏/ Net sales =COGS / Avg.
stock
Acid test / Quick = Net profit = Net ∏/ Debtors turnover =
(CA- stock –prepaid Net sales Debtors / Sales
asset) / CL