KPI analysis

Formula: Gross profit divided by sales and/or services

Definition: Gross profit indicates how much profit is made after paying for the cost of goods sold (the direct costs attributable to the production of goods and supplies such as inventory and stock). The gross profit ratio, also known as gross margin, represents gross profit expressed as a percentage of income from sales and services.

Gross profit ratios vary by industry and business. High volume businesses, such as supermarkets and retail stores, generally have low gross profit margins. Conversely, low-volume businesses, such as car yards or high fashion retail stores, generally have high profit margins.

Compare your client’s gross profit ratio to the median and range provided by Inland Revenue. The higher the gross profit margin the more efficient a business. A low gross profit ratio may indicate that a business is not charging enough for its products and services, or is paying too much for its supplies and stock.

Formula: Net profit after tax divided by sales expressed as a percentage

Definition: The net profit margin measures the percentage of each dollar of sales that results in profit. The higher the ratio, the more profitable the entity is.

This ratio has not been benchmarked by Inland Revenue and has been calculated based on the data included on the A1 and IR10 workpapers.

Formula: Cost of goods sold divided by ((opening stock plus closing stock) divided by 2))

Definition: Also known as inventory turnover, represents the number of times stock is sold and replaced within a year.

A high stock turnover may indicate:

• a high-volume low-mark-up business model,
• that the business is holding very low stock levels, or
• that the business has a lot of wastage.

A low (also known as slow stock turnover) turnover may indicate:

• a low-volume high-mark-up business model,
• that a business has too much money tied up in stock, or
• the business holds high levels of out-of-date or unsaleable items.

Formula: (Average inventory balance multiplied by 365) divided by cost of goods sold

Definition: Measures the average number of days it takes to sell inventory.

The lower the number of days, the shorter the period of time it is taking the entity to sell its inventory. Conversely, the higher the number of days, the greater the probability of slow-moving or obsolete stock.

This ratio is particularly important for businesses with high levels of inventory (e.g. Retail businesses).

The inventory turnover period is particularly industry-specific. For example, the inventory turnover period for a fruit and vegetable shop will be dramatically different from that of a luxury-car dealer.

Formula: Gross profit divided by sales and/or services

Definition: Gross profit indicates how much profit is made after paying for the cost of goods sold (the direct costs attributable to the production of goods and supplies such as inventory and stock). The gross profit ratio, also known as gross margin, represents gross profit expressed as a percentage of income from sales and services.

Gross profit ratios vary by industry and business. High volume businesses, such as supermarkets and retail stores, generally have low gross profit margins. Conversely, low-volume businesses, such as car yards or high fashion retail stores, generally have high profit margins.

Compare your client’s gross profit ratio to the median and range provided by Inland Revenue. The higher the gross profit margin the more efficient a business. A low gross profit ratio may indicate that a business is not charging enough for its products and services, or is paying too much for its supplies and stock.

Formula: Salaries and wages divided by (sales and/or services plus interest received plus dividends plus rental and lease payments plus other income)

Definition: This ratio represents the percentage of turnover income that is spent on labour costs. It can be an indicator of whether a business is spending too much or too little of its turnover income on staffing the business.

Formula: (Average net receivables balance multiplied by 365) divided by sales

Definition: This ratio measures the average number of days it takes to collect receivables. This ratio should be compared to the firm’s credit terms. For example, if a business provides credit terms of 14 days and the receivables collection period comes to 27 days, this indicates that it is taking the entity almost twice as long to collect its accounts receivable than the terms provided.

The lower the number of days, the shorter the period of time it is taking the business to collect its outstanding debts. Conversely, the higher the number of days, the longer it is taking for debtors to pay their outstanding debts, resulting in a greater probability that bad debts will arise.

Formula: Total current assets divided by total current liabilities

Definition: The current ratio represents the ratio of current assets to current liabilities and gives an indication of a business’s ability to pay its short-term liabilities.

A ratio less than 100 indicates that current liabilities are greater than current assets and that the business may struggle to pay its short-term debts. A ratio higher than 100 means a business should be able to pay its short-term liabilities. The ability to meet current liabilities in the short-term is often dependent on how liquid the current assets are.

While a high ratio is considered favourable to creditors, it may mean that the business has too much cash invested in non-interest-bearing accounts or is not utilising its cash reserves effectively. This money should be invested into assets that will generate profits for the owners.

Formula: Total current year taxable profit divided by total assets

Definition: The return on total assets represents the ratio of net income to assets. This ratio tests the efficiency of investment in fixed assets and is a measure of how effectively the business has converted these assets into net income. The higher the ratio, the more efficient a business is. The lower the ratio, and a negative ratio (loss), the less efficiently the business has used the assets.

This ratio can differ between businesses in different industries. Some businesses require significant assets, such as manufacturers and construction companies. Conversely, other businesses, such as professional service firms, including accounting and legal firms, require relatively fewer assets to generate profits. Compare your client’s return on total assets result against similar industries benchmarks.

Formula: (Total current assets minus closing stock) divided by total current liabilities

Definition: The quick ratio, also known as the acid test, is very similar to the current ratio, but excludes stock. It tests a business’s ability to pay short-term debt from immediately convertible or liquid assets (that is assets that can be readily converted to cash such as debtors, bank or cash on hand).

A ratio higher than 100 means a business should be able to pay its short-term liabilities immediately or within a very short timeframe. If the ratio is very high it may mean that the business has few current liabilities or that the quick/cash assets are very high. A ratio lower than 100 means a business could have difficulty meeting all of its short-term liabilities.

Formula: Total liabilities divided by total assets expressed as a percentage

Definition: The debt ratio measures the proportion of the businesses assets financed by debt. Specifically, it measures the relationship between total liabilities and total assets.

This ratio is a measure of safety to its creditors: the lower the ratio, the greater the asset protection to the creditors. Conversely, the higher the ratio, the more likelihood that the entity is in financial difficulty. Lenders such as financial institutions become concerned when the debt ratio approaches or exceeds 70%. However, this ratio is heavily dependent on the business profits. If a business has strong profits, its lenders are more willing to accept a higher debt ratio than a business with a poor track-record of profitability. As with the other KPIs the ratio varies between industries, so it is best to compare to results of similar industries.

Formula: Total proprietor or shareholder funds divided by (total proprietor or shareholder funds plus total liabilities)

Definition: The liability structure ratio represents equity solely as a proportion of equity plus liabilities.

A low ratio indicates a low level of owner’s equity in the business, and a higher risk to debt holders. A high ratio indicates a high level of owner’s equity in the business, and a lower risk to debt holders.