[Applause] [Music] please subscribe like and share it really helps us out and of course if you have any questions comment below and we will answer you as soon as we can [Music] welcome to this video in our series on igcse business studies this is unit 5 part 5. in today's lesson we will be learning about the analysis of accounts if you haven't seen our previous videos click on the card above [Music] so is your company doing well the data contained in the financial statements are used to make some useful observations about the performance and financial strength of the business this is the analysis of accounts of a business to do so ratio analysis is employed how do we do ratio analysis let's look at profitability ratios profitability is the ability of a company to use its resources to generate revenues in excess of its expenses these ratios are used to see how profitable the business has been in the year ended firstly return on capital employed or roce this calculates the return or net profit in terms of the capital invested in the business this capital is the shareholders equity plus non-current liabilities this is the percentage of net profit earned on each unit of capital employed the higher the roce the better the profitability is next the gross profit margin this calculates the gross profit which is sales minus the cost of production in terms of sales or in other words the percentage of gross profit made on each unit of sales revenue the higher the gpm the better now net profit margin this calculates the net profit this is gross profit minus expenses and is done in terms of sales this is the percentage of net profit generated on each unit of sales revenue the higher the npm the better [Music] now we will be looking at liquidity ratios liquidity is the ability of the company to pay back its short-term debts if it doesn't have the necessary working capital to do so it will go illiquid this means forced to pay off its debts by selling assets in 5.4 we said that working capital equals current assets minus current liabilities so a business needs current assets to be able to pay off its current liabilities the two liquidity ratios we talk about use this concept first up current ratio this is the basic liquidity ratio that calculates how many current assets are there in proportion to every current liability so the higher the current ratio the better a value above one is favorable next liquid ratio or the acid test ratio this is very similar to the current ratio but this ratio doesn't consider inventory to be a liquid asset since it will take time for it to be sold and made into cash a high level of inventory in a business can thus cause a big difference between its current and liquidity ratios what are the uses and who are the users of these accounts managers they will use the accounts to help them keep control over the performance of each product or each division since they can see which products are profitably performing and which are not [Music] this will allow them to make better decisions if for example product a has a good gross profit margin of 35 but its net profit margin is only 5 this means that the business has very high expenses that are causing the huge difference between the two ratios they will try to reduce expenses in the coming year in the case of liquidity if both ratios are very low they will try to pay off current liabilities to improve the ratios ratios can be compared with other firms in the industry or competitors also with previous years to see how they're doing businesses will definitely want to perform better than their rivals to attract shareholders to invest in their business and to stay competitive in the market businesses will also try to improve their profitability and liquidity positions each year next shareholders since they are the owners of a limited company it is a legal requirement that they are presented with the financial accounts of the company from the income statements and the profitability ratios especially the roce existing shareholders and potential investors can see whether they should invest in the business by buying shares a higher profitability the higher the chance of getting dividends they will also compare the ratios with other companies and with previous years to make the most profitable decision the balance sheet will tell shareholders whether the business was worth more at the end of the year than at the beginning of the year and the liquidity ratios will be used to ascertain how risky it will be to invest in the company they won't want to invest in businesses with serious liquidity problems [Music] now creditors the balance sheet and liquidity ratios will tell creditors and suppliers the cash position and debts of the business they will only be ready to supply to the business if they will be able to pay them if there are liquidity problems they won't supply the business as it is risky for them banks similar to how suppliers use accounts they will look at how risky it is to lend to the business they will only lend to profitable and liquid firms government the government and tax officials will look at the profits of the company to fix a tax rate and to see if the business is profitable and liquid enough to continue operations and thus if the workers jobs will be protected workers and trade unions they will want to see if the business future is secure or not if the business is continuously running a loss and is at risk of insolvency or not being liquid it may shut down operations and workers will lose their jobs other businesses managers of competing companies may want to compare their performance to or may want to take over the business and want to see if the takeover will be beneficial what are the limitations of using accounts and ratio analysis ratios are based on past accounting data and will not indicate how the business will perform in the future managers will have all accounts but the external users will only have those published accounts that contain only the data required by law hence they may not get the full picture about the business performance comparing accounting data over the years can lead to misleading assumptions since the data will be affected by inflation different companies may use different accounting methods and so will have different ratio results making comparisons between companies unreliable thank you for watching our video please like subscribe and share and comment below so we can clarify things for you you