Accounting Ratios and Conducting Business Profitability Finance Essay

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Accounting ratio are the ratios used to evaluate a quantitative analysis of information in a company’s financial statement. Ratios being expressed and counted based on the accounting figures derived from financial statements of the company. Ratios are calculated to compare to previous years, others companies, the industry, or even the economy to judge the performance of the company from current years number. Accounting ratios helps to conduct the profitability of the business which helps the management understand about the earning capacity of the business concern. It also shows the relationship between the liabilities and assets ensure the solvency of the company can be measured. Otherwise, accounting ratios is quite helpful in analysis of financial statement and also in comparative analysis of the performance. Ratios analysis will lets the outsider know about the profitability of the company and encourage them to pay for interest and dividend etc. Companies will easy to improve their weak point with the helps when compare to others companies. Accounting ration will also helps to work out the operating become more efficiency when all turnover are worked out to evaluate the performance of the business. Ratio analysis is helpful to work out short term financial position and also in the forecasting purpose. 1.1 Five different aspect of business measured by accounting ratio Accounting ratios have a various type for the business measured, there are counted and grouped into five different aspect to extrapolate the business performance. The five types of accounting ratio are: Profitability of company Liquidity of company Asset management of company Debts management and capital gearing of company Market value of investment to ordinary shareholders/ common stockholders 1.1.1 Profitability of company Profitability ratios are used to estimate a business ability and value to arise earning as compared to expenses over a specified time period. From the indicative of ratio between a competitor ratio and previous period ratio will know about the company does well or not. Profitability of company is measured by: Gross profit markup (%) = Gross profit x 100 Cost of goods sold Where Cost of goods sold = Opening stock + Purchase – Closing stock Gross profit margin (%) = Gross profit x 100 Net sales value Where Net sales = Sales – Return inwards Operating profit margin (%) = Operating profit before interest and taxation x 100 Net sales value Profit margin on sales (%) = Net income available to common stockholder x 100 Net sales value = Profit after interest, tax, preference dividend and minority interest x 100 Net sales value Basic earning power (BEP) = Operating profit before interest and taxation x 100 Total assets Where Total assets = Fixed assets + Current assets Return on total assets (ROA) = Net income available to common stockholder x 100 Total assets = Profit after interest, tax, preference dividend and minority interest x 100 Total assets Return on common equity = Net income available to common stockholders x 100 Common equity = Profit after interest, tax, preference dividend and minority interest x 100 (Ordinary share capital + Reserve) OR (Total assets – Total liabilities) 1.1.2 Liquidity of company Liquidity ratios express the ability of a company to meet its short term financial obligation. This is also the result of dividing the total cash by short term borrowing. Liquidity of company is measured by: Current ratio / Working capital ratio = Current assets . Current Liabilities Liquid ratio / quick ratio / acid-test ratio = Liquid assets . Current liabilities 1.1.3 Asset management of company Asset management of company can also called as an efficiency ratios. It is measure the quality of business receivables and how efficiently it uses and controls its assets, how effectively the firm is paying supplier, and whether the business is overtrading or under trading on its equity. Assets management of company is measured by: Inventory turnover or Stock turnover: Inventory turnover = Cost of sales OR Average stock value Stock turnover = Cost of sales . Closing stock value Average stock value = (Opening stock value + Closing stock value) / 2 Fixed assets turnover = Net sales . Fixed assets net book value Where Net sales = Sales – Return inwards Total assets turnover = Net assets where Net sales = Sales – Return inward and Total assets Total assets = Fixed assets + Current assets Debtor ratio = Debtor . Credit sales Debtor payment period = Debtor ratio x 365 days / 52 weeks / 12 months (In days / weeks / months) = Debtor x 365 days / 52 weeks / 12 months Credit sales Days sales outstanding (DSO) = Debtor x 365 days OR Credit sales = Debtor . (Annual credit sales / 365 days) 1.1.4 Debts management and capital gearing of company Debts management and capital gearing of company is measure about the total debt to its total assets of a company’s. It is also a estimate of how risky the company will be for a bank to extend a loan to company, with a higher ratio meant great risk. Debts management and capital gearing of company is measured by: Debts ratio / Total debts to total assets ratio = Total debts . Total assets Capital gearing ratio = Prior charge debts capital Total capital = Preference share capital + Debentures + Loan stock + Loan . (Ordinary share capital + Preference share capital + Reserves + Long term liabilities) OR (Fixed assets + Current assets – Current liabilities) Debts equity ratio = Total debts = Long term liabilities + Current liabilities Common equity Ordinary share capital + Reserve Times interest earned / Interest cover = Profit before interest and before taxation Interest charge Creditor ratio = Creditor . Credit purchase Creditor payment period = Creditor ratio x 365 days / 52 weeks / 12 months (In days / weeks / months) = Creditor x 365 days / 52 weeks / 12months Credit purchase 1.1.5 Market value of investment to ordinary shareholders / common stockholder Market value of investment to ordinary shareholder is related an observable market value, the price stock, to book values obtained from the firm’s financial statements. This aspect is measured by: Earnings per share = Net income available to common stockholders Number of ordinary shares in issue = Profit after interest, taxation, preference dividend and minority interest Number of ordinary shares in issue Price / Earnings ratio (P/E ratio) = Market price per ordinary share Earnings per share Dividend cover = Earnings per share OR Net ordinary dividend per share = Profit after interest, taxation, preference dividend and minority interest Net ordinary dividend Earnings yield = Gross earnings per share x 100 Market price per ordinary share = [100 / (100 – Income tax basic rate)] x Earning per share x 100 Market price per ordinary share Dividend yield = Gross ordinary dividend per share x 100 Market price per ordinary share = [100/ (100 – Income tax basic rate)] x Net ordinary dividend per share x 100 Market price per ordinary share Price / cash flow ratio = Market price per ordinary share . Net cash inflow per ordinary share = Market price per ordinary share . (Net income + Depreciation) / Ordinary shares in issue Market price / book value ratio = Market price per ordinary share . Net book value per ordinary share = Market price per ordinary share . (Common equity / Ordinary shares in issue) 1.2 Accounting ratios comparison for business performance measurement Although ratio analysis is very important tool to judge the company’s performance, comparison problem might happen in the accounting ratio for business performance measurement. 1.2.1 Inter-temporal comparison between two periods The problems of comparison affect inter-temporal are: Effects of price changes make comparisons difficult unless adjustments are made. Influences of changes in technology on the price of assets, the probably return and the future markets. Impacts of a changing environment on the results reflected in the accounting information. Potential effects of changes in accounting policies on the results. Problems associated with establishing a normal base year to compare other years. 1.2.2 Inter-firms comparison between two companies The problems of comparison affect inter-firms are: The selection of industry specifications and the effectiveness of specifications based on the averages. The two different firms are having two different financial and business risk profiles and the influence on analysis. Of course, the two different firms are using two different accounting policies. The size of business’s impacts and its comparators on risk, structure and returns. Impacts of different environments on reported results. 1.3 Companies selected for business performance measurement IJM Corporate Berhad and WCT Berhad aare choosing for the business performance measurement. IJM Corporate Berhad IJM is one of Malaysia’s leading construction groups and is listen in the main board of Bursa Malaysia. Its business activities encompass construction, property development, manufacturing and quarrying, infrastructure concessions and plantations. IJM was born in 1983 with an overarching purpose of competing more effectively against bigger foreign rivals. The company rapidly established itself as a progressively built on its competitive prowess, financial capacity and repute to strengthen its footing as a serious local contractor. IJM turned public in 1986. An application made for its shares to be listed on the Kuala Lumpur Stock Exchange (KLSE) was subsequently obtained in September 1986. WCT Berhad Established on 14 January 1981 as WCT Earthworks & Building Contractors Sdn Bhd, the Company became a public company on 1 April 1994. WCT made its debut on the Malaysia Stock Exchange on 16 February 1995. Over years, they have expending their product and services to include project management, construction design, values engineering and asset management in: F1A & international racing circuit High-rise and special purpose building; International airport;A Hydroelectric dam; Iconic infrastructure;A Township planning & development; Racecourse;A A A Commercial property development & management; Expressway & Highway; and BOT Toll Concessions.A 1.4 Financial statement analysis Based on below are the accounting ration between two companies, which is IJM Corporate Berhad and WCT Berhad. 1.5 Accounting ratio between IJM Corporate Berhad and WCT Berhad 1.5.1 Profitability Profitability between IJM Corporation Berhad and WCT Berhad are showing that higher gross profit mark up, return on total assets and return on common equity for WCT Berhad and IJM Corporate Berhad is getting the high ratio of gross profit margin, operating profit margin on sales, profit margin on sales compare to WCT Berhad. 1.5.2 Liquidity In the liquidity ratio, WCT Berhad is getting higher in current ratio, but lower in acid-test ratio compared to IJM Corporate Berhad. 1.5.3 Assets management and debts management In assets management, WCT Berhad is getting higher ratio in inventory turnover, total assets turnover, day sales outstanding and also time interest earned, but there are lower in debtor ratio and debts equity ratio compared to IJM Corporate Berhad. 1.5.4 Market value of investment to stockholders WCT Berhad is getting higher ratio of earning per share and earning yield but lower price earnings ratio compared to IJM Corporation Berhad. 1.6 Conclusion In the conclusion, I feel that accounting ratio is important to an company to calculate about their company profit value. In between of IJM Corporate Berhad and WCT Berhad, I had do the accounting ratio for both of the companies, it is successful to estimate about their ability. IJM Corporate Berhad and WCT Berhad are also ability in estimate a business value to arise earning as compared to expenses over a specified time period. In others hand, I felt that WCT company is much more ability of a company to meet its short term financial obligation because it have a higher ration compare to IJM Corporate Berhad Obviously in the accounting calculation, WCT Berhad is much more efficiency to control assets and also effective of the firm is paying supplier, but IJM Corporate is having a great risk compared to WCT Berhad. At last, calculation shown the WCT Berhad have a good market value , the price stock, and to book values obtained from firm’s financial statement.

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Accounting Ratios And Conducting Business Profitability Finance Essay. (2017, Jun 26). Retrieved October 4, 2022 , from
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