BUSF_A01.qxd

Chapter 3 • Financial statements and their interpretation

This ratio looks at the return on the longer-term providers of funds (equal in

amount to the sum of non-current and current assets less current liabilities). The log-

ical profit figure to use in calculating this ratio is the operating profit. This is because

we are considering the effectiveness of the assets financed both by the shareholders

and by the long-term lenders (non-current liabilities), and therefore we should log-

ically use the profit that is shared between these two groups.

Provided that short-term profit is not being generated at the expense of the long

term, this ratio should probably be as high as possible. In Chapter 2 we saw that it

might be open to most businesses to increase current accounting earnings and, with

them, the ROCE ratio, through taking actions that could adversely affect long-term

profitability, or at the expense of taking on higher levels of risk.

Since this ratio goes to the heart of what most private sector businesses are trying

to achieve it is sometimes known as the primary ratio.

Return on ordinary shareholders’ funds (or return on equity) ratio

×100%

The ratio for Jackson plc for 2008 is:

× 100 =19.1%

This ratio is quite similar to the previous one, but considers matters more spe-

cifically from the shareholders’ viewpoint. For this reason, the profit figure is that

which the shareholders earn after all charges have been met.

Gross profit margin

×100%

The ratio for Jackson plc for 2008 is:

× 100 =42.9%

This shows what percentage of the sales revenue remains after the expense of mak-

ing the inventories available to the customers (or the direct cost of providing the ser-

vice) is taken into account. There is a range of pricing and output strategies that a

business can apply. At one end of the range is the strategy of charging very low prices

for the output, so that customers are attracted, leading to a high sales revenue

(turnover). At the other end is the strategy of charging a fairly high price, leading to a

relatively low sales turnover. In principle neither strategy is preferable to the other.

Where in the range the business seeks to operate is a matter of managerial judgement.

In making this judgement, managers will need to take account of the nature of the

market and of the business’s own cost structure.

359

837

Gross profit

Sales revenue

78

409

Profit for the year

Share capital +reserves