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robyn pearson -CHARTERED ACCOUNTANT-
march, 2003 |
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Last month...................... My client, Jenny Brown, of Brown’s Gourmet Cellar, was discussing with me the importance of understanding financial statements. We talked about financial ratios, in particular gross profit margin (gpm). Jenny has made the point that an individual’s gpm does not need to be matched to industry. “I agree, Jenny,” I said. “For example, hypothetically the gpm for your industry may be 50%. You may take the position that you choose to sell some of your stock at reduced prices, and a lower gpm. You may achieve the same dollar gross profit by doing this, relying on an increase in volume sold” “What are some other ratios?” asked Jenny, “and what do they tell me? “You should monitor your net profit margin. This is your net profit as a percentage of sales. If your gross profit margin remains the same from period to period, but your net profit margin changes, you should analyse your operating expenses to find where the differences lie. If operating expenses have increased, you may need to either increase the price of your products, or find ways of decreasing the expenses” I replied. “Good,” said Jenny. “Now, what tools can I use to manage my cash flow?” “You will have noticed, Jenny,” I said, “that your balance sheet assets and liabilities are separated into current and non current. Current generally means payable within twelve months, or can be liquidated reasonably quickly. As a test of how liquid your business is, you may apply the current ratio. The current ratio measures your current assets as a percentage of current liabilities. A business should always have an excess of current assets over current liabilities, to be able to meet its debts in the short term. To further define the businesses ability to pay its debts, account receivable and stock should be removed from the equation. This then represents the quick ratio and assesses liquidity over and even shorter timeframe”. “So, what you are telling me is that if I look at these ratios over two different time periods, and the ratios become smaller, my business is becoming financially less viable,” said Jenny. “Could be,” I said. “However, it is possible to assess some elements within these ratios to take remedial action”. |
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