Thursday 14th September2023
Principles of Accounts
Accounting Ratios
Ratios provide a very valuable means of comparing the performance of a
business :
From one year to the next
With other similar businesses
They enable changes in important aspects of a business’s performance to
be pinpointed and quantified. If ratios are calculated every year, it is
possible to see whether any significant trends are becoming apparent.
However, it is not enough just to calculate ratios. Ratios have to be
interpreted and this requires skill and judgement if the owner or manager
of a business is to be well informed when making important decisions.
PROFITABILITY RATIOS
There are four ratios used to analyze an Income Statement
Gross profit percentage Gross Profit
Revenue x 100
Mark up Gross Profit x 100
Cost of Sales
Rate of inventory turnover Cost of sales x 100
Average inventory
Net profit percentage Net Profit x100
Revenue
Activity 1 :
A business’s income statement included the following
Income Statement for the year ended 31 December 2017
$ $ $
Revenue 240000
Opening inventory 16000
Purchases 178000
194000
Closing inventory (14000)
Cost of sales 180000
Gross profit 60000
Less : General expenses 9000
Wages 10000 (19000)
Net profit 41000
Calculate the following ratios:
a) Gross profit percentage
b) Net profit percentage
c) Mark up
d) Rate of inventory turnover
Activity 2:
Income Statement for the year ended 31 December 2019
$ $
Revenue 400000
Opening inventory 27000
Purchases 296000
323000
Less Closing inventory (23000)
Cost of Sales (300000)
Gross profit 100000
Less : General expenses 9000
Rent 17000
Salaries 44000 (70000)
Net profit 30000
From the information above, calculate the following ratios:
a) Gross profit percentage
b) Net profit percentage
c) Mark up
d) Rate of inventory turnover
LIQUIDITY RATIOS
There are five ratios used to analyze a statement of financial position
(balance sheet).
Current ratio or working capital Current Assets : Current liabilities
ratio
Acid test ratio or liquid capital ratio Liquid assets :Current Liabilities
Liquid assets (current assets –
closing stock)
Return on Capital invested Profit
Capital Employed x100
Receivables collection period Accounts Receivables
Credit Sales x 365
Payables payment period Accounts Payable
Credit purchases x 365
Activity 3:
A business had credit sales of $372000 and credit purchases of $300000 for
the year ended 31 December 2018.Its statement of financial position
(balance sheet) was as follows:
Balance Sheet as at December 2018
$ $ $
Non - Current Assets 350000 125000 225000
Current Assets
Inventory 15000
Accounts Receivable 30000
Prepayments 3000
Cash at bank 2000
50000
Less: Current Liabilities
Accounts Payable 26000
Accruals 4000 (30000)
WORKING CAPITAL 20000
245000
Financed By:
Opening Capital 225000
Add Net Profit 60000
285000
Less Drawings (40000)
245000
Calculate the following ratios:
a) Current ratio
b) Acid test ratio
c) Return on investment
d) Receivables collection period
e) Payables payment period
Activity 4 :
The following statement of financial position was prepared for the business
owned by Jackie Davis at the end of its financial year. The business had
credit sales of $224000 and credit purchases of $154000 for the year ended
31 December 2018.
Jackie Davis
Balance sheet as at 31 December 2018
$ $ $
Non - Current Assets 490000 196000 294000
Current Assets
Inventory 17000
Accounts Receivable 16000
Prepayments 1000
Cash at bank 2000
36000
Less: Current Liabilities
Bank Loan 7000
Accounts Payable 14000
Accruals 3000 (24000)
WORKING CAPITAL 12000
306000
Financed By:
Opening Capital 298000
Add Net Profit 45000
343000
Less Drawings (37000)
306000
Calculate the following ratios:
a) Current ratio
b) Acid test ratio
c) Return on investment
d) Receivables collection period
e) Payables payment period
