Calculation And Understanding of Accounting Ratios (Copy)

Gross Margin (Gross Profit Margin)

• Formula:
  Gross Margin (%) = (Gross Profit ÷ Revenue) × 100
• Indicates how much of the revenue is left after covering cost of sales.
• High margin suggests effective control over cost of goods sold (COGS).
• Example:
  Revenue = 120,000
  Gross Profit = 36,000
  Gross Margin = (36,000 ÷ 120,000) × 100 = 30%

Profit Margin (Net Profit Margin)

• Formula:
  Profit Margin (%) = (Net Profit ÷ Revenue) × 100
• Measures the percentage of sales that is actual profit after all expenses.
• High margin indicates strong cost control and profitability.
• Example:
  Revenue = 120,000
  Net Profit = 18,000
  Profit Margin = (18,000 ÷ 120,000) × 100 = 15%

Return on Capital Employed (ROCE)

• Formula:
  ROCE (%) = (Net Profit ÷ Capital Employed) × 100
• Assesses how efficiently the business uses capital to generate profit.
• Capital Employed = Capital + Non-current liabilities
  (or) Total Assets – Current Liabilities
• Higher ROCE = Better return on investment
• Example:
  Net Profit = 20,000
  Capital Employed = 100,000
  ROCE = (20,000 ÷ 100,000) × 100 = 20%

Current Ratio

• Formula:
  Current Ratio = Current Assets ÷ Current Liabilities
• Measures short-term liquidity (ability to pay short-term debts).
• Ideal range = 1.5 to 2:1
• If too low → Liquidity problems
  If too high → Inefficient use of assets
• Example:
  Current Assets = 30,000
  Current Liabilities = 15,000
  Current Ratio = 30,000 ÷ 15,000 = 2:1

Liquid Ratio (Acid-Test Ratio)

• Formula:
  Liquid Ratio = (Current Assets – Inventory) ÷ Current Liabilities
• Measures real liquidity (excluding stock which is not immediately liquid).
• Ideal ratio = at least 1:1
• Example:
  Current Assets = 30,000
  Inventory = 10,000
  Current Liabilities = 20,000
  Liquid Ratio = (30,000 – 10,000) ÷ 20,000 = 20,000 ÷ 20,000 = 1:1

Rate of Inventory Turnover (Times)

• Formula:
  Inventory Turnover = Cost of Sales ÷ Average Inventory
• Indicates how many times inventory is sold and replaced in a period.
• Higher turnover → Efficient stock control
  Low turnover → Overstocking or slow sales
• Example:
  Cost of Sales = 90,000
  Opening Inventory = 10,000
  Closing Inventory = 14,000
  Average Inventory = (10,000 + 14,000) ÷ 2 = 12,000
  Inventory Turnover = 90,000 ÷ 12,000 = 7.5 times

Trade Receivables Turnover (Days)

• Formula:
  Trade Receivables Days = (Trade Receivables ÷ Credit Sales) × 365
• Measures how quickly customers pay the business.
• Lower number = Prompt payments
  Higher number = Credit control problem
• Example:
  Trade Receivables = 18,000
  Credit Sales = 120,000
  Trade Receivables Days = (18,000 ÷ 120,000) × 365 ≈ 55 days

Trade Payables Turnover (Days)

• Formula:
  Trade Payables Days = (Trade Payables ÷ Credit Purchases) × 365
• Measures how long the business takes to pay suppliers.
• Longer period may help with cash flow but can damage supplier relations.
• Example:
  Trade Payables = 25,000
  Credit Purchases = 150,000
  Trade Payables Days = (25,000 ÷ 150,000) × 365 ≈ 61 days