A business keeps various types of financial record to monitor its performance and ensure that taxes are paid. These include cash flow statements, profit and loss accounts and a balance sheet.
Profit and Loss Account
A trading, profit and loss account shows the business's financial performance over a given time period, e.g. one year. The sales on the profit and loss account are the revenue that the business is receiving from selling products or services which was £187,730. The cost of sales then needs to be calculated in order to generate a gross profit figure. Cost of sales is the money that is needed to provide products or services to customers which was £83,000 in this ...view middle of the document...
This business is worth £34,677, financed by £34,677 of share capital and reserves. Capital and reserves are in effect liabilities, because the firm owes this money to the owners. What a firm owns, it owes. Therefore net assets and capital employed or financed by should always be the same amount.
Profitability ratios measure how much profit and organisation makes. I will look at the three main profitability ratios which are gross profit margin, net profit margin and return on capital employed.
Gross Profit Margin
The gross profit percentage ratio works out the amount of profit from the buying and selling of goods. The higher the figure is the better, preferably over 50% because then the business would have taken away overhead expenses and some profit would be left over. Two ways of improving a gross profit margin is to raise the selling price of the product, or to negotiate deals with less expensive suppliers.
Calculation for Craft & Pottery Shop GPM:
105785 (Gross Profit) / 187730 (Sales Revenue) = 0.5634954456
0.5634954456 x 100 = 56.34954456 = 56%
Here, the gross profit margin is above 50% which is ideal and illustrates that the Craft & Pottery shop are making a lot of money from sales revenue.
Net Profit Margin
Net profit margin is the percentage of revenue remaining after all operating expenses, interest, taxes and preferred stock dividends have been deducted from a company's total revenue. Net profit margin is one of the most closely followed numbers in finance. Shareholders look at net profit margin closely because it shows how good a company is at converting revenue into profits available for shareholders. The higher the net profit margin the better as it shows a business can manage their expenses well.
Calculation for Craft & Pottery Shop NPM:
18865 (Net Profit) / 187730 (Sales Revenue) = 0.1004900655
0.1004900655 x 100 = 10.04900655 = 10%
This ratio is typically lower than the gross profit margin since more costs are considered. A low margin means your net profit efficiency is below industry norms. A falling net profit margin over time is also problematic. Net profit margin can be increased by reducing other fixed costs. Optimising use of electricity to operate equipment or negotiating better rates on rent are specific measures which could improve a low net profit margin.
Return on Capital Employed
Return on Capital Employed (ROCE) is the ratio often used by venture capitalists or investors such as the Dragons in Dragons’ Den. This ratio calculates how much money an investor will get back after a period of time. It is crucial that investors weigh up the amount they will receive from the investment with the risk involved and if they would have received as good a deal (or better) if they had left the money in a bank account accumulating interest.
Calculation for Craft & Pottery Shop ROCE:
18865 (Net Profit before Tax) / 34677 (Capital Employed) = 0.5440205323...