Ratio Analysis No. 1 CMD

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Ratio Analysis No. 1

Higher/Int 2Business Management2009-2010

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Today’s Ratios Today we will look at the following ratios in

more detail:

Profitability Gross Profit Margin Profit Mark-up Net Profit Margin

Efficiency Stock Turnover

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Gross Profit MarginA reminder of the ratio:

GP % = Gross ProfitSales Revenue

x 100 1

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Gross Profit MarginThe purpose - to measure the

percentage of profit earned on the trading activities of the organisation.

The Gross Profit Margin measures how many pence Gross Profit is earned from every £1 of sales.

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Gross Profit MarginWhat is a good figure?

It is not possible to comment on what a good figure is without either:

Comparing trends over different time periods.

Making comparisons with other similar organisations.

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Gross Profit Margin If the Gross Profit Margin ratio is

high, the organisation may have a prudent buying policy.

Changes in the ratio can be caused by an increase or decrease in the selling price or an increase or decrease in the cost of goods sold.

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Gross Profit MarginThe Gross Profit Margin should be

calculated at regular intervals, with any rise or fall investigated.

If the ratio falls it may simply mean that the price of raw materials has gone up.

However it might also mean that stocks have been stolen or damaged.

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Gross Profit MarginHow can an organisation improve the

Gross Profit Margin?

They could: Raise the selling price. Look for a cheaper supplier. Choose to sell something else. Negotiate better discounts from their suppliers.

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Profit Mark-upA reminder of the ratio:

Profit Mark-up % = Gross ProfitCost of Goods Sold

x 100 1

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Profit Mark-upThe Profit Mark-up ratio measures the

percentage added to the cost of goods sold in order to arrive at the selling price.

No comments can be made on the results without comparing trends or comparisons with competitors.

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Profit Mark-upWhere the percentage is high, it may

indicate a prudent buying policy.

Changes in the ratio can be caused by an increase or decrease in the cost of goods sold (usually outwith the company’s control).

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Profit Mark-upHow can an organisation improve the

Profit Mark-up?

They could: Raise the selling price. Look for a cheaper supplier. Negotiate better discounts from their suppliers.

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Net Profit MarginA reminder of the ratio:

NP % = Net ProfitSales Revenue

x 100 1

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Net Profit MarginThe purpose - to measure the

percentage of overall profit earned by the organisation after all expenses have been taken into account.

The Net Profit Margin measures how many pence Net Profit is earned from every £1 of sales.

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Net Profit MarginWhat is a good figure?

Once again, it is not possible to comment on what a good figure is without either:

Comparing trends over different time periods.

Making comparisons with other similar organisations.

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Net Profit MarginThe Net Profit Margin is used to

highlight efficiency and control of costs.

One question which could be asked is:

Is the organisation making itself bankrupt by paying far too much in wages?

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Net Profit MarginHow can an organisation improve the

Net Profit Margin?

By improving the Gross Profit Margin.

By reducing expenses for example:

Switching off heaters and lights when not in use. Reducing personal telephone calls by staff.

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Stock Turnover RatioA reminder of the ratio:

Stock Turnover = Cost of SalesAverage Stock

Average Stock is calculated by adding the opening and closing stocks together and dividing by 2

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Stock Turnover RatioStock turnover is the average period of

time that an item of stock is held before it is used or sold.

This ratio usually depends on the type of organisation, for example:

a fast food outlet would turn over its stock many more times a year than a furniture business.

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Stock Turnover Ratio If the rate of stock turnover is

improving, its likely that the firm is holding lower average stocks and therefore operating more efficiently.

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Stock Turnover RatioHow can an organisation improve the

Stock Turnover Ratio?

They could: Introduce special offers or promotions. Introduce JIT stock management.

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Task Using the example of Edward’s Electrical

Supplies Ltd, answer the questions based on the ratios covered today.

Remember that for your NAB and final exam, it is important that you are able to describe ratios, give reasons for the results and be able to offer suggestions on how the ratios can be improved.