Ratio analysis is described as a quantitative method of exploring an organisation’s liquidity,
operational efficiency, and profitability by calculating and comparing information covered in its
financial statements.
Liquidity
Liquidity ratios measure an organisation’s capability to pay off its short-term financial obligations as
they due using the organisation’s current or quick assets.
Liquidity ratios include two ratios:
1. Current ratio – measures whether an organisation has the capital on hand to meet its short-
term obligations
current assets
current ratio=
current liabilites
2. Acid test ratio – measures whether an organisation has enough liquid assets to pay their
current liabilities
current assets−inventory
acid test ratio=
current liabilties
Profitability
Profitability ratios show how well an organisation can generate profits from its operations.
Profitability ratios include two ratios:
1. Gross profit margin – calculates the percentage of money left after deducting the cost of
goods sold
gross profit
gross profit margin= ×100
sales
2. Net profit margin – calculates the percentage of money left after deducting selling, general,
and administrative costs
net profit
net profit margin= × 100
sales
Efficiency
Efficiency ratios evaluate how competently an organisation uses its assets and liabilities to generate
sales and maximise profits.
Efficiency ratios include three ratios:
1. Debtors collection period – indicates the average number of days an organisation takes to
receive the money it’s owed from its customers
debtors
debtors collection period= ×365
credit sales
2. Creditors payment period – indicates the average number of days an organisation takes to
pay its financial obligations to its trade creditors (suppliers, vendors, other companies, etc.)
creditors
creditors payment period= ×365
credit purchases
3. Stock turnover period – indicates the number of times an organisation has sold and replaced
its inventory, or stock, during a specific period
cost of sales
stock turnover period=
average inventory
Calculations:
Liquidity
1. Current ratio
current assets
current ratio=
current liabilites
25,555
current ratio=
7,800
5,111
current ratio=
1,560
current ratio=5,111:1,560
current ratio=3.27682051
current ratio=3.28
2. Acid test ratio
current assets−inventory
acid test ratio=
current liabilties
25,555−6,800
acid test ratio=
7,800
18,755
acid test ratio=
7,800
acid test ratio=3,751 :1,560
acid test ratio=2.404487179
Profitability
1. Gross profit margin
net sales−LCOGS
gross profit margin= × 100
net sales
98,100−41,175
gross profit margin= ×100
98,100
56,925
gross profit margin= ×100
98,100
gross profit margin=0.5802752294 ×100
gross profit margin=58 %
2. Net profit margin
net profit
net profit margin= × 100
net sales
27,000
net profit margin= ×100
98,100
net profit margin=0.2752293578× 100
net profit margin=27.5=28 %
Efficiency
1. Debtors collection period
debtors
debtors collection period= × 365
credit sales=sales−returns
14,500
debtors collection period= ×365
98,780−680
14,500
debtors collection period= × 365
98,100
debtors collection period=0.1478083588 ×365
debtors collection period=53.95005096=54 days
2. Creditors payment period
creditors
creditors payment period= × 365
credit purchases= purchases+returns+ carriages
6,300
creditors payment period= ×365
40,675+500+2,040
6,300
creditors payment period= × 365
43215
creditors payment period=0.1457827143 ×365
creditors payment period=53.21069073=53 days
3. Stock turnover period
cost of sales opening stock +closing stock
stock turnover period= =cost ofsales ÷( )
average inventory 2
5,760+6,800 12,560
average inventory = = =6,280
2 2
41,175
stock turnover period= =6.556528662
6,280
stock turnover period=6.5׿