Financial Ratio Analysis
1. Gross profit margin (%) = Gross Profit/ Revenue
- Used to measure the profitability on products/services by comparing the gross profit (net sales – cost) against the net sales.
- It should be aligned with the mark-up margin as imposed by the Company.
- Ideal scenario: This will vary by business and industry. Generally, more than 40% indicating Company has the ability to manage its cost effectively.
2. Net profit margin (%) = Profit Before Tax/ Revenue
- Used to measure the profitability on business by comparing the net profit against the net sales.
- All expenses including interest will be taken into consideration in deriving the net profit.
- Ideal scenario: Consistently growth in net profit for Company, 10% considered average while 20% and above considered high (or good).
3. Current ratio (x : y) = Current assets : Current liabilities
- Used to determine if the Company will have enough capital to cover all the current liabilities.
- Ideal ratio is 2:1. Although this will vary by business and industry, a number above 2 may indicate a poor use of capital. A current ratio under 2 may indicate an inability to pay current financial obligations with a measure of safety.
4. Working capital (RM) = Current assets – Current liabilities
- Used to measure balance of working capital for Company after deducting all the current liabilities.
- Ideal scenario: Positive working capital indicating Company has the ability to pay current financial obligations with a measure of safety.
5. Gearing ratio (%) = Debt/ Networth (Equity)
- Used to indicate how much debt used to finance the business by comparing against net worth/equity.
- Ideal scenario: Less than 50% indicating Company is in good financial shape to manage its debt
6. Return on equity (%) = Profit before tax/ Networth (Equity)
- Used to measure % of return for every single RM invested into the Company.
- Ideal scenario: ROE consistently at 15% and above indicating Company has the ability to deploy its investors’ funds effectively.
7. Cash flow = Cash flow/ Profit Before Tax
- Used to measure % of cash flow for Company by comparing the amounts earned in profit.
- Ideal scenario: Ideal ratio is 100%. If lesser than 100% meaning Company takes in less cash and cash equivalents than what it earns in profits.
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