Module 7 • Control


The following three categories of ratios will be discussed: 1. Profitability ratios


How profitable the business is?


2. Liquidity ratios 3. Activity ratios


Does the business have enough money to cover its liabilities Are important areas such as stock and debtors managed well?


The information in the Budgeted Income Statement and Balance Sheet in the section of Leather Case on budgets will also be used.


IMPORTANT The numbers 1 – 9 are used to help you to find the information needed for the ratio analysis 3.3.1 Profitability ratios


Profitability should be the most important objective for your business. Is your business profitable enough when you consider the amount of money you invested in it? Profitability ratios can give you an idea of how well your business is being managed and simply whether it is worth your while keeping the business. Two ratios will be discussed. Make sure you understand the difference between “Return of Assets (ROA)” and “Return on owner’s equity (ROI). You are familiar with terms “Gross profit percentage” and “Nett profit percentage”.


• Return on assets (ROA)


“Return on Assets” is an indication of the profitability of the assets of a business. In other words: this Return on Assets indicates what a business can do with what it possesses. The “Return on Assets” is expressed as a percentage (%). It is also an indication of how well your assets have been used in the business to generate earnings (income).


When using ROA to measure the success of the business it is best to compare it against a business’s previous ROA numbers or the ROA of a similar businesses.


Return on assets can be calculated by dividing a business’s net income by its total assets: Net income/Total assets.


Use before tax figures Return on assets = Net profit Total Assets 2 + 3 – 4


What is “net income”? Net income is calculated by starting with a business’s total income. Deduct from this, cost of sales and any other expense that the business incurred during the specific financial period. This can include depreciation, interest, tax and all business expenses. “Net income” is sometimes called “net earnings” or “net profit”.


What is “total assets”?


Fixed assets + (current assets – current liabilities) = total assets The return on average assets can also be explained as follows:


1


Add fixed and net current assets and subtract current liabilities


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