The gross profit margin ratio compares an entity’s gross profit to its sales revenue, reflecting the proportion of sales revenue that results in gross profit. Example: Gross profit x 100 = x % Sales revenue Gross profit margin
22 Profitability analysis continued Net profit margin ratio revels entity’s ability to produce profit from each dollar of sales. Profit margin computed with profit (loss) as the numerator, may use EBIT Example: Net Profit x 100 = x % Sales revenue Net profit margin
23 Activity 4
24 Activity 5
25 Activity 6
26 Asset efficiency analysis Asset turnover ratio Shows an entity’s overall efficiency in generating income per dollar of investments in assets Value will depend on the efficiency with which it manages its current and non- current investments Example: Sales revenue = x times Average total assets Asset turnover ratio
27 Asset efficiency analysis continued Inventory turnover period (Days) indicates the average period of time it takes to sell inventory Inventory turnover (Times) can be calculated in terms of the number of times in a year the inventory is replaced in the business. In this case the ratio in calculated as: Example: Average inventory x 365 = x days Cost of sales Inventory turnover Cost of sales = x times Average inventory Times inventory turnover
28 Asset efficiency analysis continued Debtors turnover ratio (Days) indicates average period of days it takes to collect the money from its trade related accounts receivable Debtors turnover (Times) can be calculated in terms of the number of times in a year the business collect the money from its trade debtors. In this case the ratio in calculated as: Example: Average accounts receivable x 365 = x days Sales revenue Debtors turnover (days) Sales revenue = x times Average accounts receivable Debtors turnover (times)
29 Asset efficiency analysis continued Days inventory and days debtors turnovers can be considered together to reflect the entity’s activity cycle (also referred to as the operating cycle ) A period of time ( cash cycle ) elapses between an entity paying for the inventory, selling the inventory, and receiving cash for the inventory
30 Liquidity analysis The survival of the entity depends on its ability to pay its short terms debts when they fall due (its liquidity ) An entity must have sufficient working capital to satisfy its short-term requirements and obligations But excess working capital is undesirable because the funds could be invested in other assets that would generate higher returns
31 Liquidity analysis continued Current ratio and quick ratio Current ratio (or working capital ratio) indicates $ of current assets per $ of current liabilities Example: Current assets = x times Current liabilities Current ratio
32 Liquidity analysis continued Quick asset ratio (or acid test ratio) measures $ of current assets available (excluding inventory) to service each $ of current liabilities Example: Current assets – inventory = x times Current liabilities Quick asset ratio
33 Liquidity analysis continued Cash flow ratio
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