Accounting and Finance For Managers: Profitability Analysis Ratios

Accounting and Finance for Managers 201
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.
CONTENTS:
1) Concept of Maximising Share Holders Wealth
2) Competing Theories
3) Share Holders Relation
4) Conclusion
5) References
PROFITABILITY ANALYSIS RATIOS
Return on capital employed (ROCE)

According to Atrill and Mclaney (2008), this ratio is a “fundamental measure of
business performance”. In addition, ROCE may possibly be defined as the amount of
profit the company earns from shareholders investments (Dyson, 2004). On close
analysis of the company’s financial report, it can be noted that this ratio decreased by
34% from 13.1% in 2006 to 8.59% in 2007. The return on the capital employed for the
current operating period is below the acceptable minimum ratio of 10%. Since the
amount of capital employed remained the same over the two years, the management of
the company has been advised to review their investment strategy to deemphasise loss
making product(s).
2002
Return on capital employed = 41.4/349.7+385.1*100 = 5.634%
2003
Return on capital employed =25.4/352.4+370.4*100 = 3.514%
2004
Greenwich School Of Managment

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2005
2006
2007
Gross profit margin:

This ratio measures the amount of profit the business makes after deducting the cost of
sales from turnover. (Hall et al 2008). Our review shows that the gross margin
increased marginally by 1%. The company may need to review the sales strategy or the
direct cost profile. (Atrill, 2006).
On calculating GPM we get:-
In Millions
2002
GROSS PROFIT MARGIN =224.2/540.8*100 = 41.457%
2003
2004

0
2005
2006
2007
Net profit margin:

This measures the effectiveness of management control over direct and indirect costs.
(Dyson, 2004). Hall et al., (2008), is of the same view and claims that “net profit
margin helps to measures how company can run its overheads effectively”. This ratio
is reduced by 23% from 4.2 in 2006 to 3.22 in 2007. This reinforces our earlier call for
a review of the cost structure of the company by the management.
On Calculating Net profit Margin we get:-
In Millions
2002
Net Profit Margin=41.4/540.8*100 = 7.65%
2003
Net Profit Margin =25.4/541.1*100 = 4.694%
2004
2005

0
2006
2007
Net profit margin:
• In 2003 the net profit margin fall down and company make some losees
againt last year
• Improvement can be easily seen if we observe the Net profit of respective

margin
• improved well
• Possibly increase in sales and it is possible that they may have found new
suppliers
Operating expenses:
This relates the expenses of the company, to the turnover, generated during the year
under review. (Atrill, 2008). We noted an increase of 4% in operating expenses
between the year 2006 and reduction as one may consider the increase to be above
inflationary ratio.
In Millions
2002

0
Operating Expenses= 201.3/540.8*100 = 37.22%
2003
Operating Expenses = 210.6/541.1*100 = 38.92%
2004
2005
2006
2007
Assets turnover:
Dyson (2007) explains this ratio as the tool that compares’ the revenue earned by the
company to the total assets used to generate the revenue/turnover. Although the assets
of the company are still generating revenue, the ratio has decreased by 11% over the
two years under review.
In Millions
2002
= 540.8/706.4 = 0.765
2003
= 541.1/696.7 = 0.077

0
2004
= 433.7/666.8 = 0.650
2005
= 448.4/653.5 = 0.686
2006
= 410.8/776.8 = 0.528
2007
= 436.1/89.3 = 4.883
Asset turn over:
• The turn over which we get from fixed asset has been constant till year
2006 but there was rapid rise in 2007
• This shows that we used our resources effectively
SHORT TERM LIQUIDITY RATIOS
Current ratio:

0
This is a measure of the company’s ability to meet its current financial obligations
(usually within one year) as and when due. (Atrill, 2003). It shows how prepared the
company is to repay its current debts. This ratio is dependent on the size of the
company, and it is as Turnbull (2006) in the annual report and account explains, it is
the ability of the company to have sufficient liquid resources to meet the operational
needs of the business. From the analysis in question the current ratio of 0 .88 in 2007 is
better than the ratio relating to the prior year of 0.82. On the other hand, it is below our
expectation of between 1.5 and 2. Hence, the management should find ways of
restructuring its current liabilities to enable them to meet the maturing obligations.
In Millions
2002
= 115.1/86.7 = 1.327
2003
= 114.5/88.4 = 1.295
2004
= 133.1/95.9 = 1.387
2005
= 168.4/114.7 = 1.468
2006
= 188.3/97.4 = 1.933
2007
= 441.9/106.4 = 4.144

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Current Ratio:
• Comparing to 2002 to 2006 there was drastic increase in the year

2007
• These show that we have enough liquid resource to pay the

liabilities that are due in future
Acid test:
This is similar to the current ratio except that stocks are not included in the calculation
of the assets required to repay maturing obligations. (Atrill 2006). The constant ratio of
0.23 for the two years under review is grossly below the expected ratio of between 1
and 1.5. As suggested under current ratio, the management need to take a cursory look
at the possibility of restructuring its working capital position.
In Millions
2002
= 115.1-51.5/86.7 = 0.733
2003
= 114.5-47.3/88.4 = 0.760
2004
= 133.1-45.9/95.9 = 0.909
2005
= 168.4-59.8/114.7 = 0.946
2006

0
= 188.3-34.1/97.4 = 1.583
2007
= 441.9-37.1/106.4 = 3.804
Acid test ratio:
• Acid test ratio is similar to current ratio.
WORKING CAPITAL RATIOS
Stock days:
Atrill and Mclaney (2008) define this as a measure of the time in days it takes
a company to utilise its stock level. From our review the stock days have
increased from 65 days in 2006 to 68 days in 2007 and this results in the need
for a review of the stock control system to minimise the cost of carrying stock,
which can have a negative impact on the profitability of the company.
In Millions
2002
= 12.4/540.8*365 = 8.36 days.
2003
= 12.8/541.1*365 = 8.63 days
2004

0
= 15.5/433.7*365 = 13.07 days
2005
= 19.7/448.4*365 = 16.03 days
2006
= 16.8/410.8*365 = 14.92 days
2007
= 14.4/436.1*365 = 12.05 days
Debtor days:
• Debtors are taking more time to pay back when compared to year 2002 but if we
compare with year 2005 they have become much more quicker
• The probable reason for this may be lack of provision or discounts
Creditor days:
Atrill (2006), states that this is how quickly a company is able to pay its debts to its
suppliers and other short term creditors. According to Wragg in Rensbury and
Sheppard’s report and financial statement (2006) it has been argued that “it is the
company’s policy to adhere to the terms and condition of payment agreed with its
suppliers”. Compared to debtors days the company is advantaged by early collection
of debts from their customers and delayed payment to their suppliers, however default
on their part can worsen their credit rating. One may also note that the number of days
in 2007 (50.7days) are shorter than 59.53days allowed by suppliers in 2006.
In Millions
2002
= 37.4/316.6*365 = 43.11 days
2003

0
= 37.4/316.5*365 = 43.13 days
2004
= 40.2/209.4*365 = 70.07 days
2005
= 44.1/208.5*365 = 77.2 days
2006
= 42.8/189.6*365 = 82.39 days
2007
= 58.6/194.1*365 = 110.19 days
(a) Stock Days
It is used to find the number of days the stock is retained
FORMULA
Stock(Inventories)/Cost of Sales*365
In Millions
2002
= 51.5/316.6*365 = 59.3 days
2003
= 47.3/316.5*365 = 54.5 days
2004
= 45.9/209.4*365 = 80 days

0
2005
= 59.8/208.5*365 = 104.6 days
2006
= 34.1/189.6*365 = 65.64 days
2007
= 37.1/194.1*365 = 69.76 days
Stock days:
• No of stock days got increased dramatically by year 2005 but the number slowly
dropped down till 2007
• Type of industry or company is to be know to get into deeper details
• FINANCING RATIOS
• Gearing ratio:
• According to Dyson (2007), this measures the level of exposure of a
business to a debt on a long term basis. Ordinarily the higher the ratio the more
risky the company is rated by creditors or suppliers of business funds. Turnbull
(2006) is of the same view as he added that a company is exposed to interest
rate risk from the borrowings and also to cash flow risk by overdrawing its
account and loans. The ratio measures company’s financial risk from the
balance sheet point of view. The gearing ratios for the two comparative years

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are below 50% and therefore considered low and acceptable. However the
increase of the 258% shows that the company took an additional borrowing
which needs to be profitably used.
2002
= 349.7/349.7+385.1*100 = 47.59
2003
= 352.4/352.4+370.4*100 = 48.754
2004
= 347.2/347.2+356.8*100 = 49.318
2005
= 381.6/381.6+325.6*100 = 53.959
2006
= 461.4/461.4+406.3*100 = 53.17
2007
= 19.8/19.8+404.8*100 = 4.663
Gearing:
• The Gearing ratio was too high in year 2002 to 2006 but fortunately the ratio
lowered down drastically by year 2007
• There is a potential for the company to borrow as of year 2007

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Interest cover:
It is a measure of the company’s ability to pay interest on the amount borrowed. (Hall
et al., 2008) This ratio shows the financial risk of a company from the profit and loss
account point of view. (Dyson 2004). The cover improved from 2.4 in 2006 to 2.9 in
2007, which may be viewed as good progress.
In Millions
2002
= 41.4/23.8 = 1.739
2003
= 25.4/34.3 = 0.740
2004
= 42.5/26.7 = 1.591
2005
= 43.3/27.8 = 1.557
2006
= 55.5/29.7 = 1.868
2007

0
= 58.9/24.1 = 2.443
Interest cover:
• There was no much increase or decrease in interest cover
• Borrowing is observed to be under control.

Final Analaysis
Return on capital employee:
• There was good increase in return on capital employed for a company. It almost
got doubled by year 2007.
• Comparing with other companies gives a clearer picture of company

performance.
Gross profit margin:
• In the year 2002and 2003 the Gross profit margin remand constant. but there
was slight improvement in the next three years once again there was a
significant rise in the year 2007
• There were no change in the trading system from the year 2002 to 2007
• Gross profit margin selling price is increased

Net profit margin:
• Improvement can be easily seen if we observe the Net profit of respective

margin
• improved well
• Possibly increase in sales and it is possible that they may have found new
suppliers
Asset turn over:
• The turn over which we get from fixed asset has been constant till year
2006 but there was rapid rise in 2007

0
• This shows that we used our resources effectively
Operating expenses:
• There haven’t been much difference in operating expenses. So

expenditure of the company has all most been constant. But if we observe
clearly the expenditure has come down in the year 2007 which is good
sign of profit.
• One of main reason for this decrease may be because in number of

employees working for company
Current Ratio:
• Comparing to 2002 to 2006 there was drastic increase in the year

2007
• These show that we have enough liquid resource to pay the

liabilities that are due in future
Acid test ratio:
• Acid test ratio is similar to current ratio.

Debtor days:
• Debtors are taking more time to pay back when compared to year 2002 but if we
compare with year 2005 they have become much more quicker
• The probable reason for this may be lack of provision or discounts

Creditors days:
• There has been huge increase in creditors days
• Time taken to pay back creditors kept on increasing year by year which is not
good sign for company performance.
Stock days:
• No of stock days got increased dramatically by year 2005 but the number slowly
dropped down till 2007
• Type of industry or company is to be know to get into deeper details

Gearing:
• The Gearing ratio was too high in year 2002 to 2006 but fortunately the ratio
lowered down drastically by year 2007

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• There is a potential for the company to borrow as of year 2007.
Interest cover:
• There was no much increase or decrease in interest cover
• Borrowing is observed to be under control.
2002 2003 2004 2005 2006 2007
5.634% 3.514% 6.036% 6.122% 6.396% 13.87%

41.457% 41.489% 51.717% 53.501% 53.846% 55.468%
7.65% 4.69% 9.79% 9.65% 13.51% 13.50%
37.22% 38.92% 43.78% 44.24% 45.54% 42.21%
0.765 0.077 0.650 0.686 0.528 4.883
1.4:1 1.3:1 1.4:1 1.5:1 2:1 4.15:1

0.8:1 0.8:1 1:1 1:1 1.6:1 4:1
8.36 days 8.63 days

13.07 16.03 14.92 12.05 days
days days days
43.11days 43.13days 70.07 77.20 82.39 110.11days
days days days
59.3days 54.5 days 80 days 104.6 65.64 69.76 days
days days
47.59 48.75 49.31 53.95 53.17 4.66

1.739 0.740 1.591 1.557 1.868 2.443

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COMPETING THEORIES AND STEPS FOR SHARE HOLDERS WEALTH:
IMPLEMENTING PLANS AND GAINING PROFIT:
Some of the plans that are to be implemented by the company or an Organization are
based on improving the sales which are related to the generation of productivity. Every
company should implement some strategic plans which raise the economy on both
Investors side and Company side.
1. An arrangement of senor administration team, which includes a lot of

managing directors, to support and direct process safety, unbroken
management, and operational unbroken initiatives within a company.
2. Human act of creating a new safety and operations assigned duty
responsibilities for establishing the group operations and the standards
which are processed safely and evaluation safety and performance of the
operations.
3. Group Chief Executive has directly taken report from the safety and
function of operations.
4. The act of putting a new Group Vice president for the process of
removing impurities familiar with the work of the panel.
5. Creation of an announcement board to help company management in
the monitoring and assessing operations.
6. The act of putting retired federal Judge Stanley Sporkin to act as
receiving channel, getting solution from that and resolving the concerns
which has raised by company staff and makes profit by proper planning.
7. This represents a lot of increase in, and rate of change, spending plan.
8. The systems which are new to the market has to be taken targetly and it
should be installed and working by the end of the year 2007 a year head of
the schedule originally
9. Important in effect of the external recruitment across company’s
businesses t the increase underlying the capability in the operations and
engineering as well.
This was based in scientific and industrial progress and this instrument considers
making as well as conditions and new technologies were initiating in the products and in
the various terms of the giving and the delivery system of the company. The most
necessary and to get success in the significant contributor in organizations which
belongs to the building the relationship strongly with the value chain includes local
stakeholders, shareholders and the management entirely. Resolutions and the
conditions can benefit in the ways variously if they are sustaining clients loyally.
However, for the conditionally to be profitable for the long term, the stakeholder should
have the benefit to them. There are so many methods and ways which can be taken

0
place in the planning an efficient product operationally as well as the service strategy
deliveries, but the organizations of business suggests that the comprehensive approach
deals with the structure of an organizational and the cost preference of the market and
also the internal capabilities. The management methods consider some of the elements
and the capabilities internally such as the firms and the enterprise configuration and
characteristics of the managerial products. Without wasting effort and the methods of
sustainability requires the tasks combindly from the product design to the post-sale of
the stake holder.
The approach of a company in the management operational side is a part that the
quality should be taken historically and the method concentration at the front end, with
the initiatives like the quality o the product that was going to turn all the stake holders
and the designing of the product into the manageable system in the year 2001.For
occurrence of something, the considerations of the operating systems like JIT, although
there was a less appealing than the material usual requirements of planning systems,
they are the constants with the raising quality levels by the waste management.
CONCLUSION:
From the above discussion we concluded that the maximizing the shareholders wealth
is done by maintaining the company with new plans and ideas and to take decision
making approach by taking all share holders opinions. From this topic we have critically
analysed that the theories that are related and matched with our concepts chosen. We
have concluded that the share holder’s responsibility is to share ideas from the
company and to give any relevant ideas that make the company profitable and achieve
the goals for the company.
REFERENCES:
Frank H. Stephen, Ju¨rgen G. Backhaus (2003) Corporate governance and mass

privatisation: A theoretical investigation of transformations in legal and economic
relationships Journal of Economic Studies 30 (3/4) PP: 389 - 468
Christopher Pass, Bryan Lowes (1978) Managerial Theories of the Firm Managerial
Finance 4 (1) PP: 10 - 25
Kavous Ardalan (2003) Theories and controversies in finance: a paradigmatic overview
International Journal of Social Economics 30 (1/2) PP: 199 - 208
Joseph S. Wholey (2001). Defining, improving, and communicating program quality.
Advances in Program Evaluation,7, PP: 201 – 216.
1. Stanislaw Karapetrovic, Walter Willborn(2000)’ Quality assurance and
effectiveness of audit systems’, International Journal of Quality & Reliability
Management, 17(6), PP: 679 – 703.
2. Stanislaw Karapetrovic, Walter Willborn (2000)’ Generic audit of management
systems: fundamentals’, Managerial Auditing Journal, 15(6), PP: 279 - 294

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Accounting and Finance For Managers: Profitability Analysis Ratios

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Accounting and Finance for Managers 201

PROFITABILITY ANALYSIS RATIOS

Return on capital employed (ROCE)

Return on capital employed = 41.4/349.7+385.1*100 = 5.634%

Return on capital employed =25.4/352.4+370.4*100 = 3.514%

Return on capital employed =42.5/347.2+356.8*100 = 6.036%

Greenwich School Of Managment

Return on capital employed =43.3/381.6+325.6*100 = 6.122%

Return on capital employed =55.5/461.4+406.3*100 = 6.396%

Return on capital employed =58.9/19.8+404.8*100 = 13.871%

Gross profit margin:

On calculating GPM we get:-

GROSS PROFIT MARGIN =224.2/540.8*100 = 41.457%

GROSS PROFIT MARGIN =224.5/541.1*100 = 41.489%

GROSS PROFIT MARGIN =224.3/433.7*100 = 51.717%

Greenwich School Of Managment

GROSS PROFIT MARGIN =239.9/448.4*100 = 53.501%

GROSS PROFIT MARGIN =221.2/410.8*100 = 53.846%

GROSS PROFIT MARGIN =241.9/436.1*100 = 55.468%

Net profit margin:

On Calculating Net profit Margin we get:-

Net Profit Margin=41.4/540.8*100 = 7.65%

Net Profit Margin =25.4/541.1*100 = 4.694%

Net Profit Margin =42.5/433.7*100 = 9.799%

Net Profit Margin =43.3/448.4*100 = 9.65%

Greenwich School Of Managment

Net Profit Margin =55.5/410.8*100 = 13.51%

Net Profit Margin =58.9/436.1*100 = 13.50%

Net profit margin:

• Improvement can be easily seen if we observe the Net profit of respective

Greenwich School Of Managment

Operating Expenses = 210.6/541.1*100 = 38.92%

Operating Expenses = 189.9/433.7*100 = 43.78%

Operating Expenses = 198.4/448.4*100 = 44.24%

Operating Expenses = 187.1/410.8*100 = 45.54%

Operating Expenses = 184.1/436.1*100 = 42.21%

Greenwich School Of Managment

Asset turn over:

• This shows that we used our resources effectively

SHORT TERM LIQUIDITY RATIOS

Greenwich School Of Managment

Greenwich School Of Managment

• Comparing to 2002 to 2006 there was drastic increase in the year

• These show that we have enough liquid resource to pay the

Greenwich School Of Managment

Acid test ratio:

• Acid test ratio is similar to current ratio.

WORKING CAPITAL RATIOS

= 12.4/540.8*365 = 8.36 days.

= 12.8/541.1*365 = 8.63 days

Greenwich School Of Managment

= 19.7/448.4*365 = 16.03 days

= 16.8/410.8*365 = 14.92 days

= 14.4/436.1*365 = 12.05 days

• The probable reason for this may be lack of provision or discounts

= 37.4/316.6*365 = 43.11 days

Greenwich School Of Managment

= 40.2/209.4*365 = 70.07 days

= 44.1/208.5*365 = 77.2 days

= 42.8/189.6*365 = 82.39 days

= 58.6/194.1*365 = 110.19 days

(a) Stock Days