In a Nutshell (IV).Finance: Accounting (III)

ACCOUNTING RATIOS

1. Test of profitability, used to measure profit performance:
   1. Using loss&profit
      1. Gross profit: gross profit / sales. Value we are adding to the bought-in materials?
      2. Operating profit: operating profit / sales. How efficiently we are running the business?
      3. Net profit before and after tax: net profit before and after tax /sales. How efficiently we are running the business, after taking account of financing costs and tax
   2. Using loss&profit and balance sheet
      1. Return on Equity: Net Income/Shareholder's Equity. measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested
      2. Return on Assets: net income / total assets. Gives an idea as to how efficient management is at using its assets to generate earnings. Sometimes this is referred to as "return on investment".
2. Tests of liquidity: In order to survive, companies must also watch their liquidity position, by which is meant keeping enough short-term assets to pay short-term debts. The liquid money tied up in day-to-day activities is known as working capital, the sum of which is arrived at by subtracting the current liabilities from the current assets.
   1. Current ratio: current assets / current liabilities
   2. Quick ratio (acid test): (cash+accounts receivables + Shortterm investments) / Current liabilities. A stringent test that indicates whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory.
   3. Average collection period: http://www.investopedia.com/terms/a/average_collection_period.asp
   4. Average payment ratio
   5. Days stock ratio
   6. Circulation of working capital.
3. Test of solvency: These measures see how a company is managing its long-term liabilities
   1. Gearing, debt/equity ratio.
   2. Interest cover: annual interest / EBITDA
4. Test of growth: These are arrived at by comparing one year with another, usually for elements of the profit and loss account such as sales and profit
5. Market tests:
   1. Earnings per share: net profit / shares outsanding
   2. Price earnings ratio: market price per share / earnings per share
   3. Yield : dividend per share / price per share
   4. Dividend cover: net income / dividend
6. Other ratios
   1. Sales per invested assets
   2. Sales per employees
   3. Sales per manager
   4. …

There are some problems using ratios, which is right? accounting for inflation? are we comparing apples with pears? are we aware from seasonal factors? It will be very useful to look at other comparable businesses to see their ratios as a yardstick against which to compare your own businesses performance.

http://accountingforeveryone.com/accounting-ratios/

http://www.bized.co.uk/compfact/ratios/index.htm

BREAK-EVEN ANALYSIS

This is a technique that straddles several business disciplines. There are fundamentally two different types of cost. Fixed costs are those that don't vary with the volume of output. Variable costs are those that do change with sales levels.

The break-even equation is: Break-even point = Fixed costs / Selling price – Unit variable cost