About Lesson
Performance measurement
Ratios are used to measure business performance. We will look at ratios that measure profitability, liquidity and efficiency. They can be used to measure business performance over time or to measure business performance in comparison with other similar businesses.
The ratios, their purpose and method of calculation are summarised in the table below:
| Ratio | Method of calculation | Outcome | Use |
| Gross profit margin | Gross profit margin: (gross profit/revenue) x 100 | A higher number is better | Shows how much business revenue is converted to gross profit. |
| Mark-up | (gross profit/cost of sales) x 100 | A higher number is better | Shows how much profit a business makes as a percentage of cost of sales. |
| Net profit margin | (net profit/revenue) x 100 | A higher number is better | Shows how much net profit a business makes as a percentage and how well a business manages its cost of sales. |
| Return on Capital Employed (ROCE) | (net profit/capital employed) x 100 | A higher number is better | The amount of return made on the capital invested in the business. It is often said that it is not worth running the business if this figure is less than what could be gained by investing the money. |
| Ratio | Method of calculation | Outcome | Use |
| Current ratio | Current assets current liabilities |
A ratio between 1 and 2 is optimal | Shows how many current assets a business has available to meet current liabilities. Simply put – the ability to pay bills. |
| Acid test ratio | (current assets – stock) current liabilities |
The number should be over 1 | Similar to the above but taking out the value of stock. This is because the stock has not yet been sold and debtors and cash in hand can be converted into cash more easily to pay off debts. |
| Ratio | Method of calculation | Outcome | Use |
| Debtor days | Debtors x 365 Turnover |
A lower number is better | The number of days it takes debtors to pay off debts. |
| Creditor days | Creditors x 365 Cost of sales |
A lower number is better | The number of days it takes for a business to pay its creditors. |
| Stock turnover | Stoc Gyfartalog x 365 Cost of Sales |
A higher number is better | This measures how quickly a business sells all its stock. |
You can read more about ratios here: