GRADE 10 ACCOUNTING

GUIDELINES TO COMMENTING ON RATIO’ S

PROFITABILITY

a)     Gross Profit % on Cost of sales

Gross profit/cost of sales x100/1

b)    Gross Profit % on Sales (turnover)

                                                Gross profit/sales x 100/1     

Comment:

·         Both equations test whether the business meets its mark up %.

·         Compare this % to the expected mark up %.

·         Offer the following reasons for the difference between the actual and expected mark-up:

1.      Too much trade discount allowed.

2.      Too much seasonal sales or seasonal sales at low prices.

3.      Errors in calculating mark up or cost price.

c)     Operating profit on sales(turnover)

Operating profit/sales x 100/1

Comment:

·         Compare % of current year with previous year’s %.

·         For every R1 sale made, the business will generate x amount operating profit

– reflects how much operating expenses absorb the sales at the end of the year.

d)    Operating expenses on sales(turnover)

Operating expenses/sales x 100/1

Comment:

·         Compare % of current year with previous year’s %.

·         For every R1 sale, the business will incur x amount on operating expenses

– increasing operating expenses will result in a lower net profit.

·         Certain expenses must be controlled e.g. telephone, advertising salaries and wages...

·         These expenses must be identified and measures must be put in place to reduce them.

e)     Net profit on turnover (sales)

Net profit/sales x 100/1

Comment:

·         Compare with previous year- if decreases expenses may be too high.

·         Why?

1)      Excessive trade discounts.

2)      Seasonal sales.

3)      Inaccurate stock taking.

4)      Inaccurate stock taking.

5)      Inaccurate/incomplete record keeping.

·         Solution:

1) Better control over operating expenses.

2) Increase sales by offering discounts, promotions, price mark down etc.

3) Pay off/reduce loan debt.

f)      Return on Owners Equity

Net profit/Average capital x 100/1

How do you work out average capital?

Capital @ beginning of year + Capital @ end of year /2

Comment:

·         Compare to last year and indicate whether improved or deteriorated.

·         Is the return above an alternative investment?  E. g. Fixed deposit at the bank.

·         Should the owner be satisfied or not?

·         Should he/she consider switching to an alternative investment?

·         % should be approximately higher than 18% to make business worthwhile and investment worth the risk.

SOLVENCY RATIO

Total assets: total liabilities

Comment:

·         Acceptable norm is 1:1.

·         The ability of the business to meet its long term liabilities. E.g. Loans.

·         A business is solvent when:                 total assets>total liabilities.

·         A business is insolvent when:              total assets<total liabilities.

·         Compare to previous year and indicate whether improved or deteriorated.

·         Why? 

1)      Additional loans

2)      Additional Mortgage loans

·         Solution: Pay back loans as soon as possible

LIQUIDITY RATIO’S

a)     Current Ratio

Current assets: current liabilities

Comment:

·         Ability of the business to meet short term debts e.g. creditors.

·         Should be approximately 2:1 to avoid liquidity problems.

·         Compare to last year to see if improved or deteriorated.

·         State whether satisfactory or not.

·         Cannot be too high, as this means that funds could be tied up in the current assets which do not earn a return like other investments (fixed deposit).

·         Will the business be able to pay current liabilities?

b)    Acid Test Ratio

                                                Current assets – inventory: current liabilities

Comment:

·         This test is done to see if the business can meet short term debt under abnormal conditions e.g. economic depression, a decrease in sales...

·         Compare with previous year figures.

·         Norm is 1:1.

·         If the ratio is lower than 1, to be able to pay off short term debts the business would have to sell stock first putting the business under huge stress and could also result in stock being sold below cost.

·         Will the business be able to pay current liabilities with collections from debtors and cash on hand alone or must they sell off stock?