Analysis of accounts
Profitability ratios
$$\text{gross profit margin} = \frac{\text{gross profit}}{\text{revenue}} \times 100\%$$
$$\text{ROCE} = \frac{\text{profit}}{\text{capital employed}} \times 100\%$$
- A higher % is better — more profit kept per sale, or better use of the money invested.
Practice
Gross profit is 20,000 and revenue is 80,000. What is the gross profit margin (%)?
Gross profit margin = 20,000 ÷ 80,000 × 100% = 25%.
Liquidity ratios
$$\text{current ratio} = \frac{\text{current assets}}{\text{current liabilities}}$$
$$\text{acid test} = \frac{\text{current assets} - \text{inventory}}{\text{current liabilities}}$$
- The current ratio of ~1.5–2 is healthy; the acid test is stricter (it removes inventory).
- Internal users (owners/managers) control and plan; external users (banks, suppliers, investors) decide whether to lend or invest.
Practice
Current assets are 30,000 and current liabilities are 20,000. What is the current ratio? (give the number)
Current ratio = current assets ÷ current liabilities = 30,000 ÷ 20,000 = 1.5.
Practice
The acid test ratio is stricter than the current ratio because it:
The acid test removes inventory (slow to sell), giving a tougher test of liquidity.
You've got it
Key idea
- gross profit margin = gross profit ÷ revenue × 100%; ROCE = profit ÷ capital employed × 100%
- current ratio = current assets ÷ current liabilities (~1.5–2 healthy); acid test removes inventory
- used by internal (control/plan) and external (lend/invest) users