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Financial Formulas and Ratios

Financial Analysis Overview

Pivotal Role of Ratios

Financial formulas and ratios play a pivotal role in evaluating business profitability, financial health, and investment potential. Understanding these helps students analyze accounts, make forecasts, and improve financial decision-making.

Revenue Calculation

Revenue = Selling price per unit × Number of units sold
Revenue is the total income from selling goods or services before any costs or expenses.
Example: If 500 units are sold at $10 each, Revenue = 500 × $10 = $5,000. Revenue is the starting point for profit calculations.

Gross Profit

Gross profit = Revenue - Cost of sales
Gross profit measures profit after subtracting cost of sales (direct costs of producing goods) from revenue. Cost of sales includes raw materials and direct labour.
Example: If the revenue is $5,000 and cost of sales $3,000, Gross profit = $2,000. Gross profit indicates how efficiently production and purchasing are handled.

Net Profit

Profit = Gross profit - Expenses
Profit is the financial gain after deducting all costs and expenses. (Equivalently: Total revenue - Total costs). Expenses include overheads such as rent, utilities, salaries, and marketing.
Example: If gross profit is $2,000 and expenses are $500, Profit = $1,500. Profit shows if the business is financially successful.

Working Capital (Liquidity)

Working capital = Current assets - Current liabilities
Working capital is the money available for day-to-day operations. Current assets include cash, stock, and accounts receivable. Current liabilities are debts due within a year.
Key Takeaway: Positive working capital means the business can pay its short-term debts; negative working capital indicates potential liquidity problems.

Profit Margin (%)

Profit margin = ( Profit / Revenue ) × 100%
Profit margin expresses profit as a percentage of revenue.
Interpretation: A profit margin of 20% means the firm earns 20 cents for every dollar of sales.

Gross Profit Margin (%)

Gross profit margin = ( Gross profit / Revenue ) × 100%
Similar to profit margin, but focuses on gross profit. It shows the percentage of revenue remaining after covering production costs, helping assess pricing and cost control.

ROCE: Efficiency Metric

ROCE = ( Profit / Capital employed ) × 100%
ROCE measures how efficiently a company generates profit from its capital investment.
Capital employed is total capital invested in the business, often fixed assets plus working capital.

Investor Perspective (ROCE)

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ROCE Interpretation: A higher ROCE indicates better use of capital and is attractive to investors seeking efficient utilization of invested funds.

Business Formulas Deck
Formula
Revenue

What is the formula for calculating Revenue?

Answer
Formula

Revenue = Selling price per unit × Number of units sold

Formula
Gross Profit

How do you calculate Gross Profit?

Answer
Formula

Gross profit = Revenue - Cost of sales

Formula
Profit

Define Profit in terms of total revenue and costs.

Answer
Formula

Profit = Total revenue - Total costs

Formula
Working Capital

What does Working Capital represent?

Answer
Formula

Working capital = Current assets - Current liabilities

Formula
Profit Margin

How is Profit Margin calculated?

Answer
Formula

Profit margin = (Profit / Revenue) × 100%

Formula
Gross Profit Margin

What is the formula for Gross Profit Margin?

Answer
Formula

Gross profit margin = (Gross profit / Revenue) × 100%

Formula
Return on Capital Employed (ROCE)

What does Return on Capital Employed (ROCE) measure?

Answer
Formula

ROCE = (Profit / Capital employed) × 100%

Definition
Current Liabilities

What are Current Liabilities?

Answer
Definition

Debts due within a year like accounts payable

Concept
Positive Working Capital

Why is a positive Working Capital important?

Answer
Explanation

It means the business can pay its short-term debts

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📊 Finance Basics Quiz

1. What is the formula for calculating Gross Profit?

Gross profit is revenue minus the direct costs of producing goods (cost of sales).

2. If a company’s revenue is $10,000 and its profit is $2,000, what is its profit margin?

Profit margin = (Profit / Revenue) × 100% = (2,000 / 10,000) × 100% = 20%.

3. Which of the following best defines Working Capital?

Working capital measures funds available for daily operations by subtracting short-term debts from short-term assets.

4. A company has a profit of $5,000 and capital employed of $50,000. What is its ROCE?

ROCE = (Profit / Capital employed) × 100% = (5,000 / 50,000) × 100% = 10%.

5. Which ratio shows the percentage of revenue left after paying production costs?

Gross profit margin measures gross profit as a percentage of revenue, indicating efficiency in cost control.

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