Interpretation of Accounts

What you should be looking for when comparing accounts over two years:

Has the gross profit percentage increased?
Yes	This will indicate that either the selling price has been increased or that costs have been reduced (i.e. the gap between selling price and cost price has widened)
No	If the percentage has decreased then either the selling price has been reduced (perhaps to increase sales), or while costs have risen this has not been passed on to customers (the business may be anxious not to lose sales due to higher prices)
As a result of the change to the gross profit percentage, has the gross profit increased?
Yes	This would suggest the strategy has worked - but check net profit to ensure that expenses have not increased to the extent that the overall profit is less.
No	The strategy didn't work - the business is now making less profit than before.
Has the net profit increased?
Yes	This is a positive sign. Check to see if expenses have increased but still enabling business to earn more profit
No	If gross profit has increased and net profit reduced then the expenses must have increased significantly.
Has return on capital employed increased?
Yes	This is very positive. It is unlikely that the capital employed figure will have reduced so this must mean a higher profit has been earned improving the return on capital employed
No	Be careful here - profit may have increased but if the capital employed has also increased the return could be reduced. However this may also mean a reduction in profit.
Is the Current Ratio > 1: 1 (preferably 2: 1)?
Yes	The business is able to meet its current liabilities from within the current assets
No	The business would have difficulty in meeting its short term obligations from within the current assets.
When stock is excluded from the calculation, is the liquid ratio around 1: 1?
Yes	The business is in a good position being able to cover its current liabilities from liquid assets
No	If the liquid ratio is weak, there is a danger that the business will delay paying its suppliers to avoid borrowing from the bank. This can lead to problems if suppliers decide to remove the credit facility or take the business to court.
Does the rate of stock turnover indicate increase in sales?
Yes/No	With this ratio you need to aware of the average stock being used for each year since an increase in the average stock could cause the turnover rate to go down even when there has been an increase in sales. However, if there has been a change in the profit margin the effect can be seen with this calculation
Are customers taking longer to pay?
Yes	This could mean lack of credit control and might lead to the business taking longer to pay their suppliers.
No	This would indicate an improvement in credit control
Are we taking longer to pay suppliers?
Yes	This may be as a result of a weak liquid position or customers taking longer to pay the business. Suppliers could withdraw credit and/or take legal action.
No	This is a positive sign but check that the business hasn't increased any bank overdraft as a result.
Has the capital structure changed?
Yes	Increase in share capital or increase in loans? Higher loans increases the “gearing percentage”
No	Has return on capital employed improved?
Has earnings per share improved?
Yes	Increased profits
No	Profit may still have increased but there may now be more shares
Has dividend per share been maintained?
Yes	Positive sign as long as profits are being maintained
No	There may be more shares or it may have been decided to distribute less profit.

DE5C 34 - Preparing Final Accounts

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