Abdullah Ahmed

Accounting ratios and interpretation

 Question 5

ADDIONAL INFO .
2017
Project analysis slide 2 2018 TYPICAL RATIOS FOR THIS
KIND OF QUESTION
GROSS MARGIN 40% 43%  CURRENT RATIO 1:3
 LIQUID RATIO 0:8
PROFIT MARGIN 8% 7%

RATE OF INVENTORY TRNOVR 9 TIMES 10 TIMES Comment on the business’s

performance
RETURN ON CAP EMPLOYED 11% 7%

CURRENT RATIO 1.2:1 1.3:1

LIQUID RATIO 0.8:1 0.6:1

TRADE RECIEVABLE TRNOVR 29 DAYS 35 DAYS

TRADE PAYABLE TRNOVR 36 DAYS 30 DAYS

PROFIT $200 000 $180 000

 Important words used in the
question
Project analysis slide 3

gross profit
Profit current ratio Trade
divided by
margin Rate of inv Current ratio in receivable turn
the revenue relation to current
Profit turnover over
of the liabilities
divided Cost of sales Days taken to
business. or. . by . Liquid ratio
revenue divided by Liquid asset ratio receive a
gross profit
Profit in avg liquid asset in payment
in relation to relation to the
relation to inventory Trade payable
the revenue current liabilities
the revenue Liquid assets + turnover
assets-invi Days taken to
pay
 Constant increase in gross margin over the years

Project analysis slide 8

strength

Effect?
• Gross margin has increased by 3% b/w 2017 and 2018

Reasons
• This indicates that the business is making more revenue than last year .
• This change could be because of a decrease in the cost of sales which increases the gross
profit .
• Thus the business is doing good when it comes to the gross profit margin
 A decrease in profit margin

Project analysis slide 8

NEGATIVE

Effect?
• However the profit margin for the business have fallen from 8% in 2017 to 7% in 2018
Reasons to be excluded
• This problem is not related to the cost of sales as the gross profit margin has increased.
Reasons
• This could be because of workers not being motivated and not working productively which might have increased
inefficiency and wastage increasing other costs of the business
Solution
• In order to maintain the profit the business should try to cut down on their expenses a way to do this is by hiring
skilled workers to increase efficiency
 A decrease in return on capital employed

Project analysis slide 8 NEGATIVE

Effect?
• A decrease from 11% to 7%
Why?
• A decrease means that the business is making less profit with the same capital employed
• It also indicates that the resources are being used less efficiently
Solutions
• ROCE could be increased by increasing the profits of the business
 A increase in the inventory turnover

Project analysis slide 8

POSITIVE

Effect ?
Increase from 9 to 10
Reasons
• An increase in inventory turnover means that the sales of the business have
increased which is good this will have a positive
• However they might have increased due to a decrease In average inventory
 Decrease in liquidity ratio Increase in current ratio

Project analysis slide 8 Positive

• The average liquidity ratio for such a business is

• decrease in liquidity ratio may
0:8 the liquidity ratio last year was good [ 0,8 ] this
also be good as now less
year it has fallen to 0.6 it means that it will be
resources are tied up in the
harder for the business to pay back loans
business
• For current ratios an increase could mean that
more resources are tied up and there is
• current ratios increased so loans
inefficiency
can be paid back more easily
 trade payable turn over : trade receivable turn over

Project analysis slide 8 NEGATIVE

Effect?
• There was a 7 day gap between rec and payable in 2017 and was good as it allowed the cash
flow to move smoothly however now the gap has squeezed down to -5 days
• .
• This will stop the owner from making investments as payable are to be paid early and the cash
flow will be disturbed

Reason
• The reason behind this maybe that the suppliers are not loyal enough and want us to pay earlier
• And the increase in receivable may be because the business is trying to create more loyal
customers
Project analysis slideOverall
8 performance

• Profit has decreased by 10 percent

• The business is not in a very bad position but it needs to over come some stuff
• The liquidity ratio needs to be increased
• Expenses are to be managed
• And the gap between trade payable turnover and trade receivables turnover has to be
increased
 Question 7

Project analysis
The following ratios have been prepared slide 8 ratios for two similar business for the year ended 30 September 2018
to show comparative

Garford store Hobson stores Additional information

The usual ratio for this kind of
business is 1:2
Gross margin 33% 31%
ROITO 14 days 16 days a. For each ratio identify which
business you think is stronger and
Profit margin 9% 11%
give reasons for your choice
ROCE 14% 12% b. In each case where a business is
Current ratio 1:4 1;1 performing less well than the
other business make one
suggestion that could improve
that business ‘s performance
c. State one reasons why these
ratios may not ne strictly
comparable
 Gross margin

Project analysis
Garford 33%
slide 8
vs Hobson 31%

Although both of there gp margins are good garford has a higher percentage of It .

They could have a higher gp margin because of the following reasons

• They are good at minimizing there cost of sales
• Furthermore they might have good relations with the supplier who lets them take goods at a cheaper
price
• Also they have high revenues
Reasons for why hobson have a lower % of gp margin
• There cost of sales are high which automatically decreases the margin
 Rate of inventory turnover
Project analysis slide
Garford 14 times
8 vs Hobson 16 times

• Over here now hobson has a greater inventory turn over than garford
but there gp is still low
• This means that there problem mainly lies with the price of there
product
• The owner is probably not aware of the PED of its products and has set
a very low prices which helps him increase demand but the prices don’t
add up to form a higher gross profit

• On the other hand garford has lower inventory turnover but still has
higher revenue
• A reason could be that the proportions of there average inventory may
be bigger than that of hobsons
• Another possibility is that the piece of there product is price inelastic
that even if there selling products at a higher price customers still buy it
 Profit margin
Project Garford
analysis9% slide 8 vs Hobson 11%

EFFECT
Hobsons profit percentage is higher than garfords this could mean that hobsons
expenses are more controlled than garfords

REASON
Garfords profit % is low because of inefficient work leading to wastage and higher
inefficiency

SOLUTION
In order to correct this they need to lower there expenses and increase efficiency
 Return on capital employed
Project analysis
Garford 14% slide 8 vs Hobson 12%

• Garfords roce is higher but this does not mean that there profit is higher as roce could be
higher just because of low capital invested

• However hobsons is lower this means that the business is not using its resources
effectively
• In order to increase ROCE
• The business can decrease the amount of capital employed or can try to increase revenue
*usual cr for this type
of business 1:2* Current ratio
Project analysis slide 8
Garford 1:4 vs Hobson 1,1

• According to my opinion hobson has a better cr than Graford's

• However hobson seem to have less resources tied up and is making efficient use of them
• However it may be harder for them to pay off loans

• Whereas garford has a higher ratio

• This means that there are a lot of resources tied up
• But they may find it easy to pay back loans

They could improve their ratio by decreasing drawings

 WHY THESE RATIOS MAY NOT BE USEFULL

• However these ratios may not be useful when comparing business's that were opened with a lot
of time gap
• E.g. if one business was set up in 1990 the prices of land and resources were relatively cheaper
however a business which sets up in the current year may find it more expensive

Project analysis slide 8