Analysis Of Accounts (Copy)

5.5 Analysis of Accounts

5.5.1 Profitability

• Concept:
  • Measures how efficiently a business generates profit from sales and investments.
• Importance:
  • Attracts investors.
  • Ensures long-term survival and growth.
  • Used for comparing with competitors or past performance.

5.5.2 Liquidity

• Concept:
  • The ability of a business to pay its short-term debts.
• Importance:
  • Ensures day-to-day operations continue.
  • Prevents insolvency/bankruptcy.
  • Helps gain trust of creditors and suppliers.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Business Studies Full Scale Course

5.5.3 Interpreting Financial Performance

• Profitability Ratios:
  1. Gross Profit Margin (GPM)
     • Formula:

       Gross profit ÷ Revenue × 100
       

     • Shows profitability before expenses.
     • Higher % = business controls cost of sales well.
  2. Profit Margin (Net Profit Margin, NPM)
     • Formula:

       Profit ÷ Revenue × 100
       

     • Shows profitability after all expenses.
     • Higher % = efficient cost control.
  3. Return on Capital Employed (ROCE)
     • Formula:

       Profit ÷ Capital employed × 100
       

     • Measures return for owners/investors.
     • Higher % = better use of invested funds.

• Liquidity Ratios:
  1. Current Ratio
     • Formula:

       Current assets ÷ Current liabilities
       

     • Ideal ratio ≈ 1.5–2 : 1
     • Too high = inefficient use of assets; too low = liquidity problem.
  2. Acid Test Ratio (Quick Ratio)
     • Formula:

       (Current assets – Inventories) ÷ Current liabilities
       

     • Excludes inventories (harder to turn into cash quickly).
     • Ideal ratio ≈ 1 : 1.
     • Lower than 1 = risk of not paying short-term debts.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Business Studies Full Scale Course

5.5.4 Why and How Accounts are Used

• Users of Accounts and Ratio Analysis:
  • Owners/Shareholders:
    • To check profitability, decide on dividends, future investment.
  • Managers:
    • To plan, control, and make decisions about expansion or cost reduction.
  • Employees:
    • To see job security and potential wage increases.
  • Banks/Creditors:
    • To judge ability to repay loans/credit.
  • Government:
    • To assess tax liabilities, monitor compliance.
  • Investors:
    • To decide whether to invest or not.
• How ratios help in decision-making:
  • Show financial health clearly.
  • Identify strengths/weaknesses.
  • Allow comparisons:
    • Over time (trend analysis).
    • With competitors (benchmarking).
  • Support decisions on lending, investing, or restructuring.

Quick Recap Keywords

• Profitability = ability to generate profit.
• Liquidity = ability to meet short-term debts.
• Ratios:
  • GPM, NPM, ROCE (profitability).
  • Current ratio, Acid test (liquidity).
• Users of accounts: owners, managers, employees, banks, government, investors.
• Ratios help: compare performance, guide decisions, show strengths and weaknesses.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Business Studies Full Scale Course