Exam Support:

Ratio analysis performed below is also examinable in F2 Management Accounting. However, it is recommended that you spend some time learning it, even if you have already passed F2.

Ratios are important part of ACCA syllabus. It is also examinable in ACCA Paper F5, F7, F9, P2, P3, P4 and P5. Ratios are also a part of ACCA Paper F8 and P7, but they are rarely examined.

These ratios can be classified into following categories

Ratios | Details |

Profitability ratios. | It focuses on profitability of organization. It can be by not for profit organizations. |

Working capital & liquidity ratios. | It focuses on measuring effectiveness of working capital management and cash flow position of the organization |

Gearing ratios. | It focuses on measuring financial and business risk of the organization. |

Investor ratios. | It focuses on measuring attractiveness of organization for investors. |

## 1 Profitability ratios

### 1.1 Gross Profit Margin

Formula:

Gross profit margin is the percentage of gross profit on sales revenue.

It gives % of profit charged from customers on selling price of the products.

Required:

SOCI (extract) for the year-ended | 30 May 2010 | 30 May 2011 | ||

Workings | $ | Workings | $ | |

Sales revenue | (10,000 x $3) | 30,000 | (11,000 x $4) | 44,000 |

Cost of sales | (10,000 x $2) | 20,000 | (11,000 x $2) | 22,000 |

Gross profit | 10,000 | 22,000 |

Required:

Calculate gross profit margin and interpret the results?

Solution:

Formula:

**Gross profit margin (2010)**

It suggests that 33.33% of selling price is gross profit earned from customers.

**Gross profit margin (2011)**

It suggests that 50% of selling price is gross profit earned from customers.

**Growth/ (Decline) rate**

It suggests increase in gross profit % per sale by 51.51% than previous year.

Better profitability performance than previous year.

Exam Support:

Increase in % and increase in amount are two different things. Do not use interchangeably.

### 1.2 Net/Operating Profit Margin

Formula:

Net profit margin is the percentage of net profit on sales revenue.

It gives % of profit charged from customers on selling price of the products after deducting all the operating cost incurred by organization.

Operating cost includes:

- Administration cost
- Selling & distribution cost

It excludes:

- Cost of sales
- Finance cost

Illustration:

SOCI (extract) for the year-ended | 30 May 2010 | 30 May 2011 | ||

Workings | $ | Workings | $ | |

Sales revenue | (10,000 x $3) | 30,000 | (11,000 x $4) | 44,000 |

Cost of sales | (10,000 x $2) | 20,000 | (11,000 x $2) | 22,000 |

Gross profit | 10,000 | 22,000 | ||

Operating cost | 5,000 | 17,000 | ||

Net Profit | 5,000 | 12,000 |

Required:

Calculate Net profit Margin and interpret the results?

Solution:

Formula:

**Net profit margin (2010)**

It suggests that 16.66% of selling price is Net profit after recovering total cost.

**Net profit margin (2011)**

It suggests that 11.36% of selling price is Net profit after recovering total cost.

**Growth/(Decline) rate**

It suggests Decrease in Net profit % per sale by 31.81% than previous year.

Poor profitability performance than previous year.

### 1.3 Cost of Sales Percentage

Formula:

*Or*

Where 100 represents sales revenue.

Cost of sales only included expenses, which are incurred for manufacturing of the product.

It is results in residual (remaining) percentage of gross profit.

Example:

If gross profit margin is 20%, than cost of sales % should be 80%.

Illustration:

SOCI (extract) for the year-ended | 30 May 2010 | 30 May 2011 | ||

Workings | $ | Workings | $ | |

Sales revenue | (10,000 x $3) | 30,000 | (11,000 x $4) | 44,000 |

Cost of sales | (10,000 x $2) | 20,000 | (11,000 x $2) | 22,000 |

Gross profit | 10,000 | 22,000 |

Required:

Calculate cost of sale percentage and interpret the results?

Solution:

Formula:

**Cost of sales % (2010)**

It suggests that 66.67% of sales price is cost of sales recovered from customers.

**Cost of sales % (2011)**

It suggests that 50% of sales price is cost of sales recovered from customers.

**Growth/(Decline) rate**

It suggests decrease in cost of sale% per sale by 25% than previous year.

Better cost of sales control than previous year.

### 1.4 Operating Cost Percentage

Formula:

*Or*

Where 100 represents sales revenue.

Illustration:

SOCI (extract) for the year-ended | 30 May 2010 | 30 May 2011 | ||

Workings | $ | Workings | $ | |

Sales revenue | (10,000 x $3) | 30,000 | (11,000 x $4) | 44,000 |

Cost of sales | (10,000 x $2) | 20,000 | (11,000 x $2) | 22,000 |

Gross profit | 10,000 | 22,000 | ||

Operating cost | 5,000 | 17,000 | ||

Net Profit | 5,000 | 12,000 |

Required:

Calculate operating cost percentage and interpret the results?

Solution:

Formula:

**Operating cost % (2010)**

It suggests that 16.67% of sales price is operating cost incurred during the period.

**Operating cost % (2011)**

It suggests that 38.63% of sales price is operating cost incurred during the period.

**Growth/(Decline) rate**

It suggests increase in operating cost % per sale by 131% than previous year.

Poor operational costs control than previous year.

### 1.5 Sales Growth or Decline Percentage

Formula:

Sales growth is the percentage increase in current year sales over previous year sales.

Negative percentage represents decrease in sales revenue from previous year.

It suggests changes in sales revenue due to changes in any or all of following variables, which are selling price and sales volume.

Illustration:

SOCI (extract) for the year-ended | 30 May 2010 | 30 May 2011 | ||

Workings | $ | Workings | $ | |

Sales revenue | (10,000 x $3) | 30,000 | (11,000 x $4) | 44,000 |

Cost of sales | (10,000 x $2) | 20,000 | (11,000 x $2) | 22,000 |

Gross profit | 10,000 | 22,000 |

Required:

Calculate sales growth or decline % and interpret the results?

Solution:

Formula:

It suggests increase in sales revenue % by 46.67% than previous year.

More demand or market share for products than previous year.