THE PREPARATION AND ANALYSIS

OF FINANCIAL STATEMENT OF THE

SOLE TRADER

SECTION 5
 OBJECTIVES
1. List at least 5 accounting ratios. [current ratio, acid test
ratio and return on capital employed]
2. State the formula for calculating each ratio.
3. Explain the financial position of a business based on
formulas calculated.
4. State the purpose of each ratio.
 RATIO ANALYSIS
Ratio analysis is the use of accounting ratios to
show the relationship between different aspects of
the business. They also permit comparison of the
business with other similar businesses as well as
comparing the performance of the business from
year to year. Ratios are also indicators of the
business’s financial position and enable owners and
managers to make informed decisions.
TYPES OF RATIOS
PROFITABILITY RATIOS
Measure how much profit is generated from the activities of the
business.
Ratios Formulas
• Gross profit percentage: Gross profit / sales x 100
• Net profit percentage: Net profit / sales x 100
• Return on capital employed: Net Profit / Capital employed x 100
• Expenses to sales: Expenses / sales x 100
• Average stock: Opening stock + Closing stock / 2
• Stock turn/Rate of turnover: Cost of sales / average stock
LIQUIDITY RATIOS
Measure the ability of the business to pay its debts and how much
cash is available to pay for those debts.
Ratios Formula
• Working capital: Current assets – Current liabilities
• Current ratio: Current assets/current liabilities
• Acid test or quick ratio: Current assets – closing stock/current
liabilities
• Debtors Sales ratio: Debtors /Sales for the year x 12
• Creditor Purchases ratio: Creditors / Purchases for the year x 12
 The financial position of a business based on formulas
calculated.
• Financial statements are analyzed and interpreted for
internal and external parties. It is important to remember
that a ratio on its own is of no use at all. It must be
compared with previous years’ results or the results of a
competitor to be meaningful.
Purpose of each ratio.
• The use of the profitability ratios ensure owners of
business keep a careful check on figures such as cost of
goods, sales, expenses, gross and net profit.

• Liquidity ratios measure the ability of a business to pay

its debts as they fall due and ensure smooth cash flow.
INTERPRETATION OF RATIOS
Although there is no “right” ratio there is usually a
desired level that a business may want to achieve.
These levels are sometimes determined by the
industry or the type of business. For instance, a
current ratio of 2.5:1 indicates that the business is
healthy and capable of meeting obligations when
they are due. If perhaps, the ratio falls to 0.1:1. The
owners then should begin taking steps to correct the
situation. One thing is certain is that ratios are
critical to decision making in organization.
 ACTIVITY
The following information relates to the Sole Trading business of
Dwayne Brown for the period ending November 30, 2020:
$
Opening stock 2 500
Sales 25 975
Purchases 10 850
Closing Stock 1 280
Total Expenses 10 900
1. Prepare a Trading and profit and loss account (Income Statement)
for the period ending November 30, 2020
2. Using this information calculate the following ratios:
a. Gross profit percentage
b. Net profit percentage
c. Average stock
d. Net Profit
CLASS ACTIVITY
CHAPTER 39

 EXERCISE 39.1