Working with Numbers

In its most basic form, profit is simply gross sales or turnover minus the cost of obtaining those sales.

So if you made £1m in sales or turnover, but it cost £500,000 in advertising and staff salaries to get those sales, then your profit would be £500,000.

Below are a list of further definitions of profit.

Profitablity Ratios:

Gross Margin

(ie gross profit as a percentage of sales)  = (gross profit / turnover) x100

Operating Profit Margin

(ie operating profit as a percentage of turnover) = (operating profit / turnover)

Operating profit is profit before interest and tax.

Operational Gearing

This is dependent on the fixed costs in the company. Fixed costs are incurred whether the company makes any sales or not eg staff salaries and the renting of offices. Variable costs depend on sales and are directly proportional to turnover – they vary based on volume eg utilities and delivery costs.

Operational Gearing = (turnover – variable costs)/operating profit or

(operating profit + fixed costs)/variable costs

Return of Capital Employed (ROCE) = (operating profit / capital employed) x 100 – this assesses performance in relation to all providers of finance.

Return on Equity (something shareholders often look out for) = (net profit / equity) x 100 – this measures the profit that the firm or company has made relative to the investment made by the shareholders.

Liquidity Ratios

Current Ratio = current assets/current liabilities

Current assets are assets that are expected to last or be in use for less than a year. They include cash and other assets such as government securities and temporary investments which are expected to be turned into cash within one year of the balance sheet date.

Current liabilities are amounts that are due to be paid to creditors (people you owe money) within a year. Examples of these include money owed to suppliers, bank loans, rental payments, and income taxes, amongst others,

VALUATION RATIOS

The following ratios are typically used in Value Investing – ie investing where you buy a stock for a “cheap” price and hold it for a long time.

The other major type of investing is investing for “Growth”  – where you buy a stock or share that is rapidly increasing in value. These tend to be technology stocks, like google, for example, which floated (listed on the stock exchange at $85 in 2004 and reached over $1,000 in 2013. A return of over 900%. That’s pretty damn good! So if you’d invested $100 in google then, your money would have increased to over $1,250, when Google first hit $1,000 in October 2013.

PE Ratio = Share Price/Earnings Per Share

Earnings per Share = Current Earnings/Number of ordinary shares outstanding

ACCOUNTING EQUATION AND VARIOUS RATIOS (profitability and liquidity ratios)

In accounting, the balance sheet shows the Accounting equation.

The Accounting equation is a fundamental principle in accounting and is as follows:

Assets – Liabilities  = Net Assets =  Shareholders’ funds.