Blacksacademy
Business Studies
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Subject: Accounting and Finance
Title : Profitability Ratios
Ratios to examine profitabilityThe fundamental profitability ratio is Return on Capital Employed (ROC)
Without an intimate knowledge of the company it is not possible to say for certain whether these figures do represent a developing problem within the company. The company may have been forced to increase sales by lowering price.
This could happen as a result of aggressive competition, and would reduce profit margins. If there is an internal problem, then without looking further at the Balance Sheet, it would not be possible to identify the actual source of inefficiency, but some kind of inefficiency seems to be creeping into the company’s production system.
The expansion of the company in terms of sales may be introducing diseconomies of scale. The administration may be overexpanding and bureaucratic procedures introduced. Alternatively, the company may not be investing in long term capital items at all, and may be building up unnecessary piles of stocks.
Further analysis of liquidity would be required to discover the cause.
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Subject: Accounting and Finance
Title : Profit and Loss Account
AccountsFinancial accounts are records of the payments and receipts made by a company in the creation of their profits – or losses.
They are also statements of the assets of the company. Financial accounting uses the distinction between direct costs and indirect costs in order to analyse where costs arise, and hence profitability.
As the distinction between direct and indirect costs implies, costs arise in two ways – either directly through the cost of raw materials and labour involved in the production of a specific unit of output, or indirectly through the administration costs of running the business as a whole. This applies to all businesses, but particularly applies to those businesses that produce more than one product. Here they are sharing the administrative cost of running the whole firm amongst several products. Indirect costs arise in a different way to direct costs, and are treated differently by accountants and businessmen. Success in business means ruthless scrutiny of costs.
Whatever the business, costs must be examined carefully, and kept down wherever possible. The control of expenditure tends to differ according to whether the cost is direct or indirect. For example, direct costs are kept down by making better deals with suppliers of raw materials, and productivity deals with the workforce.
They might be improved by changes in production technique. Indirect costs, however, refer largely to the cost of management, and these are kept down by efficient management.
It is not efficient, for example, to have too much factory space. The cost of this good must be divided in some way between the products, and too much space means that each product is costing more to produce than necessary. Direct costs are also called costs of sales and indirect costs are sometimes called overheads.
Profit and loss
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