Calculated Accounting Ratios and Profit Margin - Case Study Example

Student Name: Tutor: Title: Accounting ratios and report Course: Calculated accounting ratios Gross profit margin = Gross profit ÷ sales (industry = 40%) Gross profit margin (Leicester) = 23,000/65,000 ×100 = 35.38% Gross profit margin (Nottingham) = 70,000/300,000 ×100 = 23.33% Gross profit margin (Kettering) = 70,000/135,000 ×100 = 51.85% Operating profit margin= Operating income (gross profit less operating expenses) ÷ sales Operating profit margin (Leicester) = (13,500/65,000) ×100 = 20.769 = 20.77% Operating profit margin (Nottingham) = (23,000/300,000) ×100 = 7.666 = 7.67% Operating profit margin (Kettering) = (15,000/135,000) ×100 = 11.111 = 11.11% R.O.C.E (Return on Capital Employed) = net profit before interest and tax ÷ capital employed (total assets-current liabilities) (industry =25%). R.O.C.E (Leicester) = 13,500/ (60,500-11,000) ×100 = 13,500/49500 × 100 = 27.27% R.O.C.E (Nottingham) = 23,000/ (95,000-47,000) ×100 = 23,000/48,000 × 100 = 47.92% R.O.C.E (Kettering) = 15,000/ (81,000-17,000) ×100= 15,000/64,000 ×100 = 23.44% (Nikolai, Bazley & Jones, 2009) Current ratio = current assets ÷ current liabilities (industry’s =1.5) Current ratio (Leicester) = 27500/11,000 = 2.5 Current ratio (Nottingham) = 57,000/47,000 = 1.21 Current ratio (Kettering) = 19,000/17,000 = 1.12 Acid test ratio = (current assets – stock)/current liabilities Acid test ratio (Leicester) = (27,500-14,000)/11,000 = 13,500/11,000 = 1.23 Acid test ratio (Nottingham) = (57,000-37,000)/47,000 = 20,000/47,000 = 0.43 Acid test ratio (Kettering) = (19,000-8,000)/17,000 = 11,000/17,000 = 0.65 Asset turnover = net sales ÷ Total assets Asset turnover (Leicester) = 65,000/60,500 = 1.07 Asset turnover (Nottingham) = 300,000/95,000 = 3.16 Asset turnover (Kettering) = 135,000/81,000 = 1.67 (Brigham & Houston, 2009) Report and recommendation Profit margin 2011 2012 Leicester 30% 35.38% Nottingham) 25% 23.33% Kettering 40% 51.85% The industry gross profit margin is 40% and the managers are keen to see that the competitors do not outperform the company. In this regard, Kettering profit margin is above the industry’s profit margin. 51.85% is 12.85% above the average in the industry. Leicester posted a profit margin of 35.38% which is close to the industry’s average. In the case of profit margin, Nottingham fails to meet the industry’s average of 40% and instead posts a profit margin of 23.33%. Using gross profit margin, Nottingham did not meet the required threshold. However, this cannot be the only basis of suggested that Nottingham should be the UK subdivision that should be closed down. Further study of other performances may reveal a different trend. This is to say that in terms of gross profit, Nottingham subdivision realized the lowest profits as compared to the other two (Kettering and Leicester). Moreover, a company can post a high gross profit but a low net profit owing to the amount of operating expenses that have been incurred. In the year 2011, Nottingham still posted a gross profit margin of 25% which is below the industry’s average. Leicester posted 30% whereas Kettering posted 40% which is barely the industry’s average in terms of gross profit margin. Operating profit margin 2011 2012 Leicester 20% 20.77% Nottingham 10% 7.67% Kettering 10% 11.11% The industry’s average operating profit margin is 17%. Operating profit margin is obtained by subtracting operating expenses from the gross profit. This means that the higher the operating profit margin, the better a company or a subdivision is doing. Leicester had an operating profit margin of 20.77%. This means that is performed better that the other two subdivisions and the figure is above the industry’s average by 3.77%. Therefore, this division in Leicester was above average as compared to the other subdivisions. The other two subdivisions (Kettering and Nottingham) fall below the industry’s average of 17% but of the two, Nottingham slips down to 7.67% which is 9.33 below the industry’s average. Kettering subdivision has its operating at 11.11% which is 5.89% below the industry’s average. This shows that of the three subdivisions with regard to operating profit margin Nottingham still performed poorly as compared to the other two; but Leicester was above the target. In the previous year, apart from Leicester which posted 20% operating profit margin, the other two subdivision posted 10% each and hence failed to meet the industry’s average. R.O.C.E 2011 2012 Leicester 30% 27.27% Nottingham 50% 47.92% Kettering 40% 23.44% The industry average of Return on Capital Employed (R.O.C.E) was 25%, both Leicester and Nottingham post R.O.C.E which is above the industry’s total. This has been brought about owing to the higher amount of current liabilities that substantially reduces the capital employed hence a higher percentage. In this case, Kettering posted 23.44% which is below the industry’s average of 25%. Leicester was slightly above the industry average of 25% at 27.27%. Current ratio 2011 2012 Leicester 1.8 2.5 Nottingham 1.0 1.21 Kettering 1.2 1.12 A company requires current assets to assist it run its daily operations (Thukaram, 2007). The industry’s average of current ratio was 1.5. Both Kettering failed to attain above the industry’s average with regard to the current ratio. Kettering has a current ratio of 1.12 which was the lowest while Nottingham had 1.21 which is slightly below the industry’s average. In this case, Kettering was the worst performer. Leicester posted a strong current ratio of 2.5. Current assets were many as compared to current liabilities. Nevertheless, stock could be contributing to the high amount of current assets which is not a good thing. Acid test ratio 2011 2012 Leicester 1.5 1.23 Nottingham 0.8 0.43 Kettering 1.0 0.65 The industry average of acid test ratio is 1. Both Nottingham and Kettering fall below the industry’s average. Nottingham is the worst performer among the three. Leicester once again performs above average of the industry’s expectations according to the management. 1.23 is 0.23 above what was needed. Kettering is 0.35 below the industry’s average while Nottingham is Asset turnover 2011 2012 Leicester 0.8 1.07 Nottingham 2.0 3.16 Kettering 1.5 1.67 The industry’s average asset turnover is 1.2. Nottingham and Kettering subdivisions have their value above the industry’s average. Nottingham had 3.16 while Kettering posted 1.67. Although Leicester is below the industry’s average, it is not very far from the industry average. From the previous year posting, it can be noted that Leicester performance improved. This is the only ratio that Leicester has not posted a good performance. Recommendation Looking at the gross profit margin, operating profit margin, and acid test ratio, it is appropriate to say that Nottingham subdivision is the one that has to be closed. Leicester and Kettering have performed well save for a few areas that can be improved but in terms of profitability, Nottingham will be the subdivision that has to be closed in case the company wants to avoid the heavy fines. References Thukaram, R.M.E., 2007, Management Accounting, New Age International, London. Brigham, F.E. & Houston, J.F., 2009, Fundamentals of Financial Management, Cengage Learning, New York. Nikolai, L.A., Bazley, J.D. & Jones, J.P., 2009, Intermediate Accounting, Cengage Learning, New York. Read More