This article throws light upon the top three types of revenue statement ratios. The types are: 1. Expenses Ratio 2. Earning Ratios 3. Profit Cover Ratios.
Type # 1. Expenses Ratio:
(a) Fixed Expenses to Total Cost Ratio:
It indicates the idle capacity in the organisation. If this ratio gradually increases without, however, a corresponding increase in fixed assets, the matter should be analysed and scrutinized carefully.
Fixed Expenses to Total Cost Ratio = Fixed Expenses/ Total Cost
(b) Material Consumption to Sales Ratio and Wages to Sales Ratio:
These indicate the percentage of Materials and Wages to Total Sales. The higher the ratio, the smaller will be the margin of profit.
(i) Material Consumption to Sales Ratio =Material Consumption/ Sales
(ii) Wages to Sales Ratio = Wages /Sales
(c) Office and Administration, Selling and Distribution Expenses to Sales Ratio:
These also indicate the percentage of Office and Administration and Selling and Distribution expenses to Total Sales.
(i) Office and Administration expenses to Sales Ratio =
Office and Administration Expenses/Sales
(d) Operating Ratio:
This is the ratio of operation expenses or operating cost to Sales. It may be expressed as a percentage and it reveals the amount of sales required to cover the cost of goods sold plus operating expenses. The lower the ratio the higher is the profitability and the better is the management efficiency. 80% to 90% may be considered as normal.
Operating Ratio = Cost of Goods Sold + Operating Expenses/Sales.
Type # 2. Earning Ratios:
(a) Gross Profit Ratio:
This is the ratio of Gross Profit to Net Sales and expressed as a percentage. It is also called Turnover Ratio. It reveals the amount of Gross Profit for each rupee of sale. It is highly significant and important since the earning capacity of the business can be ascertained by taking the margin between cost of goods and sales.
The higher the ratio, the greater will be the margin, and that is why it is also called Margin Ratio. Management is always interested in a high margin in order to cover the operating expenses and sufficient return on the Proprietors’ Fund. It is very useful as a test of profitability and management efficiency. 20% to 30% Gross Profit Ratio may be considered normal.
Gross Profit Ratio = Gross Profit/Net Sales × 100.
[Net Sales = Gross Sales – Returns Inward – Cash Discount Allowed.]
(b) Net Profit Ratio:
This is the ratio of Net Profit to Net Sales and is also expressed as a percentage. It indicates the amount of sales left for shareholders after all costs and expenses have been met. The higher the ratio, the greater will be the profitability and the higher the return to the shareholders. 5% to 10% may be considered normal. It is a very useful tool to control the cost of production as well as to increase sales.
Net Profit Ratio = Net Profit / Net Sales × 100.
(c) Operating Profit Ratio:
It is a modified version of Net Profit to Net Sales. Here, the non-operating incomes or expenses are to be adjusted with the Net Profit in order to ascertain the amount of Operating Net Profit. It indicates the amount of profit earned for each rupee of sales after dividing the Net Sales to Net Operating Profit. It is also expressed, as a percentage.
Operating Profit Ratio =Operating Net Profit/Net Sales × 100
[Operating Net Profit = Net Profit – Income from external securities and others, i.e., Interest, Dividends, Profit on Sales of Fixed Assets etc.]
Type # 3. Profit Cover Ratios:
(a) Dividend Coverage Ratios:
i. Preference Shareholders’ Coverage Ratio:
It indicates the number of times the Preference Dividends are covered by the Net Profit (i.e., Net Profit after Interest and Tax but before Equity Dividend). The higher the coverage, the better will be the financial strength. It reveals the safety margin available to the Preference shareholders.
ii. Equity Shareholders’ Coverage Ratio:
It indicates the number of times the Equity dividends are covered by the Net Profit (i.e.. Net Profit after Interest, Tax and Pref. Dividend). The higher the coverage, the better will be the financial strength and the fairer the return for the shareholder since maintenance of dividend is assured.
(b) Interest Coverage Ratio:
It indicates the number of times the fixed interest charges (Debenture Interest, Interest on Loans etc.) are covered by the Net Profit (i.e. Net Profit before Interest and Tax). It is calculated by dividing the Net Profit (before Tax and Interest) by the amount of fixed interest and charges.
The higher the coverage, the better will be the position of Debenture-holders or Loan Creditors regarding their fixed payment of interest, the greater will be the profitability, and the better will be the management efficiency.
(c) Total Coverage Ratio:
It expresses the relationship that exists between the Net Profit before Interest and Tax to Total Fixed Charges (Total Fixed Charges = Interest on loan + Pref. Dividend + Repayment of Capital etc.) It also indicates the number of times the total fixed charges are covered by the Net Profit. Naturally, the higher the coverage the greater will be the profitability.
From the following particulars submitted by D. Co. Ltd. Compute the following Revenue Statement Ratios: i.e.:
(a) Fixed Expenses to Total Cost Ratio,
(b) Material Consumption to Sales Ratio;
(c) Wages to Sales Ratio;
(d) Office and Administration to Sales Ratio;
(e) Selling and Distribution to Sales Ratio :
(f) Operating Ratio;
(g) Gross Profit Ratio;
(h) Net Profit Ratio;
(i) Operating Net Profit Ratio;
(j) Dividend Coverage
[(i) Preference Shareholders Coverage Ratio; (ii) Equity Shareholders Coverage Ratio];
(k) Interest Coverage Ratio;
(I) Total Coverage Ratio.