3.6+Ratio's

Ratio's are formulas, thus they show a relationship between two set of figures. Getting a result to the formulas is Step 1 - which is the relatively easy step. You then need to interpret the results, and then recommend ways in which to manipulate the results - think of a nalyzing your Accounts as being like a trip to the DOCTOR......



The Doctor will check the __physical health__ of your body, by carrying out ** different tests ** to measure different aspects of your health (blood pressure, sugar levels, heart rate etc etc). To do this they will have ** different tools ** (stethoscope, thermometer etc etc). Having diagnosed your health **they do not stop there** - they go on to prescribe ** appropriate solutions ** (eg painkillers, exercise more, cut down on fatty foods etc) to restore you to full health.

Similarly a Finance Manager will check the __financial health__ of the business by carrying our** different tests **to measure different aspects of the firm (liquidity, profitability, efficiency etc). To do this they will have ** different tools ** (G.P.M., Gearing ratio, Acid Test ratio etc). Having diagnosed your health ** they do not stop there ** - they go on to prescribe ** appropriate solutions ** (eg switch advertising media, import your raw materials, make staff redundant etc) to restore you to full health.

................................................................................................................................................................................................................................... = = =Gearing ratio =



Significance
 * The gearing ratio is used by analysts to determine how healthy a corporation is, in terms of ‘how it funds its operations’.
 * Essentially it measure this : what percentage of the ‘Net Capital Employed’ is __borrowed__ capital. Borrowed capital of course has responsibility and liability attached to it. So generally a lower Gearing Ratio is better.
 * A Gearing Ratio of 70% means of every $1 invested in the business $0.70 of it was borrowed money. The other $0.30 was internal (obviously).
 * Investors think of it as a “queue to get to the profits”- high Gearing means there is a long queue and they will normally join the back of it, so find that unattractive.

Older established businesses will usually have higher gearing ratios due the fact that banks trust them and have an established relationship with them and so lend money more readily. Equally manufacturing firms that use a lot of capital often use loans to purchase these assets - which are required to generate new businesses - so they too have much higher gearing ratios.

GEARING RATIO = __LOAN CAPITAL__ X 100 .ignore this nn. NET CAPITAL EMPLOYED // Both sets of data are found in the Balance Sheet. //



Use any source of finance (Retained Profit, Owners Savings, Share Capital) to pay off Loan Capital - thus reducing the numerator, and lowering the result.

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Liquidity Ratios ’Liquidity’
 * is focused on the short term (ie “Current”) - nothing Long Term or Fixed is considered.
 * measures the ability of the firm to pay bills (which firms want you to pay NOW), take advantage of cash discounts (which are only offered if you PAY CASH) or limited offers ( promotions that only last for a SHORT TIME) etc etc -
 * it does this by looking at the relationship between __current__ assets and __current__ liabilities.

• Cash is the most liquid of all assets ! - and because not all current assets can be immediately turned into cash easily (eg how quickly can a firm really sell its stocks?) a firm with good liquidity would expect to have at least $2 in current assets for every $1 in current liabilities. • Firms with poor liquidity could .... [i] end up facing fines - utilities providers (eg Anda) do this regularly, [ii] losing their goodwill, [iii] have credit lines removed, [iv] supplies withheld - and [v] in extreme cases forced into ‘Liquidation’*

* this is where Fixed Assets are sold off hurriedly, often undervalued, to turn them into cash - which then goes to the creditors.

There are 2 Liquidity Ratio’s [1] __Current Ratio__ •Is generally accepted that a current ratio between 1.5 and 2.0 is desirable.

= __ CURRENT ASSETS __ CURRENT LIABILITIES Both sets of data are found in Balance Sheet

[2] __Acid test ratio__ ‘Acid Test’ is translated as “Prueba de Fuego” • Is generally accepted that AT ratios of 1.0 to 1.5 is desirable.

It is similar to the current ratio except that it ignores stock while it measures the short-term liquidity of a business. The formula is: = __ CURRENT ASSETS - STOCK __ ....... CURRENT LIABILITIES Both sets of data are found in Balance Sheet

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">Why ignore ‘stock’? : because there is no guarantee that anyone will buy our stock therefore its the Acid Test : to measure Liquidity without it.

<span style="background-color: transparent; color: #38761d; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">If the result of the ratio is eg 1.37 it is expressed as 1.37:1. It means (in the case of Current ratio) that for every $1 you owe in current liabilities, you have $1.73 worth of current assets.

__**<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">WEAKNESS **__ •Liquidity ratios __ assume __ that certain assets of a business can be turned into cash quickly, without losing their value, in order to meet financial commitments. In reality it might well be necessary to reduce the price of your assets - especially if they need to be sold quickly.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 16px; text-decoration: none; vertical-align: baseline;">AND NOTE: liquidity ratio’s above the desirable figures can be considered undesirable too. It indicates you have too much of your wealth tied up in current assets, particularly cash. Cash is lazy, it doesn't do anything. You need to use that cash, invest it, get it out there earning for you.



................................................................................................. * * * * * * * *

If you have a low current ratio, it can be improved by a combination of : [selling Fixed Assets and converting them into cash would be one way of doing this]
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: initial; vertical-align: baseline;">raising the value of current assets and

// be careful about using cash to buy stock - cash would go down by the same value as stock would go up and you'll have the same Current Ratio & a // // worse Acid Test Ratio //

[negotiating a long term loan to pay off Overdrafts would be one way of doing this]
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: initial; vertical-align: baseline;">reducing the value of current liabilities.

// be careful about using cash to pay off Overdrafts - liabilities would go down - but so would cash !! //

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">...................................................................................................................................................................................................................................

Shareholders Ratio: Shareholders (existing and potential ) will use these to assess whether investing in the firm and purchasing its shares was a good idea.



<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; vertical-align: baseline;">__Shareholders ratios__ <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">: measures the ‘returns’ to shareholders in a company. ie they have spent their money on purchasing the shares, now what will they get in return?
 * **Existing shareholders** will be interested in the dividend they earn in relation to [1] the selling price of the shares [2] dividends of other shares in other companies [3] interest rates.
 * **Potential shareholders** will be interested in the possible earning of each share, in relation to [1] the purchase price of each share

Earnings Per Share (EPS <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; vertical-align: baseline;">__)__

EARNING PER SHARE = __NET PROFIT AFTER TAX & INTEREST__ found in Profit and Loss account IGNORE THIS VVVVVVVVV NUMBER OF ORDINARY SHARES f ound in Balance Sheet, or given in the text

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">This ratio shows the **maximum dividends that could be paid to shareholders**.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">How? .....
 * The __numerator__ is the “profit available for distribution to shareholders”- as all costs have been taken off at this point. It does not mean the shareholders will get 100% of this, the firm may wish to ‘retain’ some. Its just the maximum available.
 * The __denominator__ is the total amount of shares that need to be rewarded with dividends.

The higher the EPS ratio the higher will be the probability of shareholders receiving a large dividend payout per share. The ratio gives a good indication of the value of the company

A result of 0.45 would mean that every share has the possibility to reward the shareholder a maximum of $0.45. To give it a context you would need to know the price of the share eg $1.00, then $0.45 represents a 45% return. This 45% could be compared with eg bank interest rates.

__Dividend Yield:__ DIVIDEND YIELD = __DIVIDENDS PER SHARE__ X 100 found in Balance Sheet, or given in the text

ignore this stuff here MARKET PRICE OF EACH SHARE Found in Balance Sheet, or given in the text
•It measures the return on a share in relation to its current market price. •If two firms, for example, pay out the same dividend but the shares of the first company are half the price, the former represents a better investment for shareholders. •In general, the higher the ratio the better for its shareholders – at least in the short term.

If it is low, it might be for two reasons: 1) The dividends per share is low. 2) The market share price is high.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">•A low dividend yield may initially look bad, but it should be put into context first.eg if the company has decided to invest for the future rather than to please shareholders through large dividend payments in the short term, then a low dividen yield would not be as bad as it seems.

A result of 0.45 would mean for every $1 you spend on purchasing the share you will get $0.45 back in dividends. Remember that is just ‘dividends for //that// period’, you will of course be eligible for dividends //every future period// as well and hopefully very soon make your $1.00 [and more] back.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; vertical-align: baseline;">__NOTE__ <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;"> : you sometimes need separate formulas to work out the figures required. EG if you given the amount of Share Capital Raised (in the Balance Sheet) and the amount of shares, you can work the ‘market price of each share’



<span style="background-color: #ffffff; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">[1] anything that improves your Net Profit (see Profitability Ratios) will improve your EPS. [2] Dividends per share can be determined (raised/lowered) via voting at an AGM [3] If the company wants to lower the ‘number of ordinary shares’ it can borrow money and buy back outstanding shares of stock, however this will increase debt eg Gearing

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Efficiency Ratios

First : what exactly is ‘** efficiency **’? : Efficiency is how well the business turns its **inputs** into an **output**. Its a **relationship** between the two.
Then : how does it differ from its cousin '** productivity **' ? : //Texts differ here,// but productivity is more limited to **how much** you produce. No relationship between anything, just total up the outputs.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">Eg.. <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">FirmA is more ** productive **<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">, FirmB is more ** efficient **
 * FirmA **<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;"> produces 30 units from its 3 machines,
 * FirmB **<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;"> produces 25 units from its 2 machines.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">And it is because efficiency measures a ‘relationship’, we find that in these formulas the source of the figures for the numerator and denominator tends to be from the Balance Sheet <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; vertical-align: baseline;">__and__ <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;"> the Profit & Loss Account. A relationship between the 2 sets of accounts....
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">The ratios... **

<span style="background-color: #ffffff; color: #222222; font-family: Verdana; font-size: 13px; text-decoration: none; vertical-align: baseline;">The efficiency ratio refers to how much revenue a firm can generate (found in the P/L account) based on how much it spent (found in the BS).

<span style="background-color: #ffffff; color: #222222; font-family: Verdana; font-size: 13px; text-decoration: none; vertical-align: baseline;">In other words, it means how much ‘money/return’ you can make based on the resources that you employed. I <span style="background-color: #ffffff; color: #222222; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">t refers to the use of resources so as to maximize the production of goods and services. <span style="background-color: #ffffff; color: #222222; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">It basically means how much you can get out of the resources you have.

Return On Capital Employed

RETURN ON CAPITAL EMPLOYED = __NET PROFIT b4 TAX & INTEREST__ x 100 // found in Profit and Loss account // [R.O.C.E.] AT ALL IGNORE THIS WRITING TOTAL CAPITAL EMPLOYED ......... // found in Balance Sheet //

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">ROCE refers to percentage obtained from the investment (Capital Employed). <span style="background-color: transparent; color: #6aa84f; font-family: Arial; font-size: 15px; text-decoration: none; vertical-align: baseline;">A result of 35% means that for every $1.00 employed/invested in the business, a return (NP b4 T&I) of $0.35 was made.

Debtor Days error alert *CASH PAYMENT __ from __ Customers DEBTOR DAYS = __DEBTORS__ x 365 found in Balance Sheet ignore this wir SALES REVENUE found in Profit and Loss account

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">This ratio is used to work out : **how many days on average it takes a company to get paid [ ie receive the payment] for what it sells.** IF ALL YOUR SALES ARE IN CASH - YOU OFFER NO CREDIT TO CUSTOMERS - YOU HAVE NO DEBTORS, THEN YOUR DEBTOR DAY RATIO IS ZERO.

<span style="background-color: transparent; color: #6aa84f; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">An answer of ‘21’ means on average the firm takes 21 days to collect the payment for good sold. In other words “A customers takes the product on credit on the 1st January and only actually pays for it on the 21st January”

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">The lower the number of debtor days, the better, as cash in hand is always better for liquidity.

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">An abnormally high figure suggests inefficiency through ....
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: initial; vertical-align: baseline;">potential bad debts (if you allow them so long to pay they may feel they can get away with not paying at all)
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: initial; vertical-align: baseline;">window-dressing of the Sales Revenue figures, ( The P&L Account looks good, with high figures, but you don't actually have that figure in cash)
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: initial; vertical-align: baseline;">deliberate bullying by large monopsonistic customers trying to improve their own cash management. They want to take your product but not pay you for it until they themselves have sold it on. Thus all the risk is yours.
 * <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: initial; vertical-align: baseline;">Cash businesses, including most retailers, food vendors etc should have very low figures because everyone pays in cash.

Creditor Days

CREDITOR DAYS = __CREDITORS__ x 365 found in Balance Sheet ignore this writing TOTAL CREDIT PURCHASES* found in Profit and Loss account

*Important : Most often ‘Total Credit Purchases’ are interpreted as ‘Cost Of Sales’

<span style="background-color: transparent; color: #6aa84f; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">An answer of ‘21’ means on average the firm takes 21 days to pay for goods they take from their suppliers. In other words “A firm takes the product on credit from its suppliers on the 1st January and only actually pays for it on the 21st January”

<span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">You tend to want this to be as high as possible however if its really high firms can find themselves in liquidity problems in the future as they ‘forget’ about or ‘deprioritize’ paying, and then find themselves with no cash when the deadline arrives.

__A key comparison__ : <span style="background-color: transparent; color: #000000; font-family: Arial; font-size: 13px; text-decoration: none; vertical-align: baseline;">Firms should seek to avoid a situation where their Debtor Days is significantly longer than their Creditor Days

Stock Turnover <span style="display: block; font-family: Calibri; font-size: 16px; line-height: 1.5; text-align: justify;">This ratio examines the relationship between ... <span style="display: block; font-family: Calibri; font-size: 16px; line-height: 1.5; text-align: justify;">There are **2 formulas** that should get you to arrive at the **same conclusion** [1] STOCK TURNOVER = __COST OF GOODS SOLD*__ found in Profit and Loss account IGNORE THIS WRITING IT AVERAGE STOCK found in Balance Sheet
 * <span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">the ‘cost of goods sold’ __during__ a particular period of time and
 * <span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">the ‘value of average stock held’ __at the end__ of that particular period.
 * <span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">During the period Jan - Dec 2011 we sold goods that costs us $50 000 to make/buy
 * <span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">on the 31st Dec 2011 we had $1 000 worth of stock in our storeroom/shelves etc
 * The ratio looks at how many times a year does the firm complete the cycle of sell and re-stock, sell and re-stock...
 * ‘Stock held’ is also sometimes known as ‘inventory’ and you might find the ratio being explained as “evaluating the efficiency with which a firm is able to manage its inventory.”

<span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">* 'GOODS SOLD' = 'SALES MADE' WHICH MEANS 'COSTS OF GOODS SOLD '= COSTS OF SALES' <span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">It is expressed in ‘number of times (per year)’. <span style="background-color: #ffffff; color: #38761d; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">An answer of ‘8’ means every year the firm sells all its stock and re-stocks it shelves **8 times a year**

<span style="background-color: transparent; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">[2] STOCK TURNOVER = __AVERAGE STOCK__ x 365 found in Balance Sheet

IGNORE THIS WRITING IT COST OF GOODS SOLD found in Profit and Loss account It is expressed in ‘number of days’.

<span style="background-color: #ffffff; color: #000000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">* Average Stock - may be calculated by : [Opening Stock + Closing Stock ] / 2 <span style="background-color: #ffffff; color: #38761d; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">An answer of ‘8’ means the firm sells all its stock and re-stocks its shelves **every 8 days.**



How to improve your Creditor Days?
 * You could simply pay sooner, but only if your cash flow allows it.
 * Perhaps just tighten up on your spending. Purchase only what's vital. Introduce a bit of J.I.T.

How to improve your Debtor Days? Its usually about negotiations with your customers.
 * You could simply offer shorter credit to them, this would reduce the numerator and lower the result, however you may lose customers who go to rival firms who are still offering the longer credit.
 * You could offer discounts to customers who pay sooner however this will also reduce your Sales revenue figure.

How to improve your ROCE?
 * Manipulating the denominator is unlikely. The capital has already been invested, and reducing for the future is possible but usually a sign of troubled times. The focus should be on increasing the numerator. See hints on Profitability Ratios for that.

<span style="background-color: transparent; color: #ff0000; font-family: Calibri; font-size: 16px; text-decoration: none; vertical-align: baseline;">How to manipulate ‘stock turnover’:
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">Any kind of promotional activity such as advertising or price reductions should reduce ‘Closing Stock’ therefore reduce ‘Average Stock’ therefore improve Stock Control
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">Reducing your Product Range to only those products that sell quickly will also help. Supermarkets keep a careful record of this and are forever manipulating their products ranges, where they stock a certain product etc etc
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">Anything that cuts the ‘lead time’ : which is the time difference between receiving the inputs from suppliers and selling the output to customers.
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">JIT can also help- this would reduce the average cost
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">Increasing the Cost Of Goods Sold is not really recommended.

<span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">Stock control is particularly important for firms
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">that sell perishable goods.
 * <span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">that have restrictions on their storage space.

<span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">As always look at the context of the firm ... eg a Stock Turnover of 40 days would be disastrous for a bakery, but excellent for a jewellery.

<span style="background-color: transparent; color: #333333; font-family: Calibri; font-size: 15px; text-decoration: none; vertical-align: baseline;">....................................................................................................................................................................................................................................


 * PROFITABILITY **

Profitability ratios measure a company’s ability to : **generate __profit__ relative to __sales__.** This means....
 * What are profitability ratios? **
 * the numerator is always Profit (different versions of Profit, though) and
 * the denominator is always Sales Revenue

They highlight how effectively the profitability of a company // is being managed //.

YOU MUST KNOW THESE FORMULAES.......

PROFIT PER PRODUCT = PRICE PER PRODUCT - COST PER PRODUCT TOTAL PROFIT = PROFIT PER PRODUCT x NUMBER OF PRODUCTS SOLD
 * [BASIC] **

[PRECISE]
GROSS PROFIT = SALES - COST OF SALES NET PROFIT = GROSS PROFIT - OVERHEADS



There are 2 Profitability Ratio’s....

1. Gross Profit Margin This measures Gross Profit relative to Sales.

It is important to remember the formula for Gross Profit = Sales - Cost Of Sales
 * Costs Of Sales = Variable Costs = Direct Costs.
 * Cost Of Sales = Opening Stock + Stock Purchased - Closing Stock

This mean it is a measure of how much Sales you make in relation to variable costs such as Raw Materials (& sometimes labour).


 * Gross Profit ** particularly measures the performance of the ** Production Department ** as they are the ones responsible for process the stock/ factor inputs

A healthy Gross Profit will give an indication of what resources we have for overheads like advertising, rent etc.

Formulae = __Gross Profit__ x 100 ..................... Sales Revenue


 * An answer of ‘40%’ means that for every $1 generated in Sales Revenue you remain with $0.40 of Gross Profit (which means you spent $0.60 in variable costs). **
 * It is difficult to say what is a typical number as it will vary considerably from industry to industry - but remember that you still have overheads and possible interest to pay, as well as wanting some Dividends and Retained Profit therefore anything under 60% could be a worry. **

2. Net Profit margin This measures Net Profit relative to Sales.

It is usually the 'Net Profit BEFORE Tax and Interest' as tax and Interest are determined by outside forces and not linked to efficiency.


 * Net Profit ** particularly measures the performance of a wider range of internal stakeholders, depending on which Overhead is influencing the NPM margin
 * eg If NPM was low because of the high cost of Salaries - that might be the responsibility of the HRM Dept
 * eg If NPM was low because of the high cost of Promotion - that might be the responsibility of the Marketing Dept

Formulae =: __Net profit before Interest and Tax__ x 100 ....................... Sales Revenue


 * An answer of ‘20%’ means that for every $1 generated in Sales Revenue you remain with $0.20 of Net Profit (which means you spent $0.80 in total costs). **
 * If you follow it on from the examples above it would be : $.60 in variable costs and $0.20 in fixed costs. **
 * Again it is difficult to say what is a typical number as it will vary considerably from industry to industry - but remember that you still have interest and tax to come out, as well as wanting some Dividends and Retained Profit therefore anything under 30% could be a worry. **




 * G.P.M. **


 * ** Cheaper Suppliers - negotiate your supply contract, look for cheaper alternatives, perhaps import? **
 * ** Economies of Scale - buy in bulk an push down the price per unit **
 * ** Change the formula of your product - eg if its 60%milk and 40% water - and water is cheaper, go with 55% milk and 45% water. **
 * ** Change labour wage systems - improve motivation get workers producing more units for less pay. **

// Remember anything that improves GPM will also automatically improve NPM because (NP = GP - Overheads) //
 * N.P.M. **
 * ** Change location to reduce rent costs **
 * ** Reconsider advertising campaign and change to cheaper media. **
 * ** Restructure Salary systems **
 * AND... **
 * **<span style="font-family: 'Times New Roman'; font-size: medium; line-height: 1.5; vertical-align: baseline;">Increase Sales - this will affect both - but be careful when you recommend this because most ways to increase sales involve increasing costs too - eg advertise more, improve the quality, train the workforce, move to a better location.: so i ****<span style="font-family: 'Times New Roman'; font-size: medium; line-height: 1.5; vertical-align: baseline;">f you recommend this solution be careful to analyse it. **
 * ** Change Price - OK this will (hopefully) 'Increase Sales'which is the point above. Any mention of this as a solution should have the word ' elasticity ' somewhere in the answer..  **