These are all measures of the overall nancial

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Unformatted text preview: here, there are better explanations available in financial management textbooks. Experts will almost always agree on the importance of following changes in a ratio over time, and on the wide variations of standards depending on the type of business. PROFITABILITY RATIOS Most business plans include some standard business ratios. • Gross Margin: sales minus cost of sales, expressed as a percentage of sales. • Net Profit Margin: net profit divided by sales, as a percentage. • Return on Assets: net profit divided by the total assets. • Return on Equity: also return on investment (ROI). This ratio divides net profit by net worth. HURDLE: THE BOOK 17.4 ON BUSINESS PLANNING Return on Equity or Return on Investment (ROI) is probably the most important of these ratios. A business is an investment and it should yield profits comparable to alternative investments, unless there is additional compensation (such as salaries for the owners). In theory, at least, if ROI is low, you should sell the business and put your investment money to better use. Return on Assets and the Net Profit Margin provide a good basis for comparison between your company and the rest of the industry. They are also good indicators of company performance from year to year. ACTIVITY RATIOS Activity ratios focus on financial performance. These ratios are generally used to compare a company’s performance to the average for its industry. Levels of acceptability tend to vary widely between different industries. For example, large manufacturing companies might have a very low assets turnover, but retail stores should have a high turnover. • Accounts Receivable Turnover: sales on credit divided by accounts receivable. This is a measure of how well your business collects its debts. • Collection Days: accounts receivable multiplied by 360, then divided by annual credit sales is another measure of debt collection and value of receivables. Generally, 30 days is exceptionally good, 60 days is bothersome, and 90 days or more is a real problem. This varies by industry. • Inventory Turnover: cost of sales di...
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This note was uploaded on 01/26/2014 for the course BUINESS 102 taught by Professor Unknown during the Winter '09 term at University of Phoenix.

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