Analysis of Accounts

Capital employed is shareholders’ equity plus non-current liabilities and is the total long-term and permanent capital invested in a business. 

Ratio analysis comparing two figures from the accounts. 

Liquidity is the ability of a business to pay back its short-term debts. 

Profitability 

Profitability is the measurement of the profit made relative to either the value of sales achieved or the capital invested in the business. 

ROCE (return on capital employed) = Net profit *100/capital employed

Gross profit margin = Gross profit*100/Revenue

Net profit margin = net profit*100/revenue

Liquidity 

Illiquid means that assets are not easily convertible into cash. 

1. Current ratio = current assets*100/current liabilities
2. Acid test ratio = (Current assets – inventories)*100/current liabilities

Limitation of accounts and ratio analysis

• While managers have access to full data, external users will only be able to access published data which is often restricted to what is mandated by the law.
• Ratios are based on past accounting data and may not indicate how a business will perform in the future.
• Accounting data will be affected by inflation and annual comparisons may be misleading
• Different companies will use different accounting methods such as the valuation of their assets, this may make comparison of financial accounts of different businesses difficult