Level IV Manage and Maintain

Small/Medium Business Operations

LO1 Identify daily work requirements
1.1 Work Identification and Allocation
• Every job has a job profile. A job profile usually consists of
two parts- job description and person specification.
• These two in turn will help you to identify the job
requirements.
Job Description
• It is a written record of the duties and responsibilities
associated with the particular job.
• Job description serves a dual purpose,
– Making it easier to match the right person to the right job, and
– Informing all employees what their jobs entail.
Cont’d

• In preparing a job description, the following details must be

included:
– A general description of the job
– The duties to be performed
– The job responsibilities
– Specific skills needed
– Education and experience required
• It is used to assess whether someone has the right
skills/knowledge and experience for the job.
Person Specification
• The person specification consists of the essential as well as
the desirable qualities of the person who is to perform the
job; these include
– Qualifications
– Experience
Cont’d
• Skills and abilities
– Personal qualities/attitudes
• Once everything is put down on paper, the employer is ready to
start looking for the person who fits the job description as well
as the person specification
• Job analysis is a process in which employers identify and
determine the particular job duties and the relative importance
of these duties for a given job.
• During job analysis, the following leading questions should be
asked as a guide by anyone who hires, be it the business owner,
the manager or supervisor:
– What work has to be accomplished?
– How many people are needed?
– Would part-time help be sufficient?
– What are the skills being looked for?
Cont’d
– Will additional help be needed to do it?
– How much experience is required?
– How much payment will entail?
1.2 Business Environment
• A business organization cannot exist in a vacuum. It needs
– living persons,
– Natural resources
– Places and
– Things
– The sum of all these factors and forces is called the business
environment.
– Therefore, business environment may be defined as a set of
conditions namely Social, Legal, Economical, Political or
Institutional that are uncontrollable in nature and affects
the functioning of an organization.
Characteristics of Business Environment
1. Business environment is compound in nature.
2. Business environment is constantly in a changing
process.
3. Business environment is different for different
business units.
4. It has both long term and short term impact.
5.Unlimited influence of external environment
factors.
6. It is very uncertain.
7. Inter-related components.
8. It includes both internal and external environment.
Cont’d
• Business environment is of two types:
(i) Internal Environment: It includes the 5 M’s i.e. man,
material, money, machinery and management, usually
within the control of business.
• Business can make changes in these factors according to
the change in the nature of its activities.
(ii) External Environment: It includes those factors
which are beyond the control of business enterprise.
• These factors are: Government and Legal factors, Geo-
Physical Factors, Political Factors, Socio-Cultural Factors,
Demo-Graphical factors etc.
• External Environment is of two types:
1.Macro/General Environment
2. Micro/Operating Environment
Cont’d
Macro/General Environment: – It includes factors that
create opportunities and threats to business units. The
followings are elements of Macro Environment
• Economic Environment
• Legal Environment
• Socio-Cultural Environment
• Technological Environment
• Natural Environment
• Demographic Environment
Micro/Operating Environment This is the environment
which is close to the business and affects its capacity to
work.
• It consists of Suppliers, Customers, Market
Intermediaries, Competitors and Public.
1.3 Action Plan

• Action Plan is a sequence of steps that must be taken,

or activities that must be performed well, for
a strategy to succeed
• An action plan has three major elements
(1) Specific tasks: what will be done and by whom.
(2) Time horizon: when will it be done?
(3) Resource allocation: what specific funds are
available for specific activities?
• Each step or change to be sought in an action plan
should include the following information:
– What actions or changes will occur
– Who will carry out these changes
– By when they will take place, and for how long
– What resources (i.e., money, staff) are needed to carry out
these changes
Cont’d
Realistic Timelines and Priorities
• Realistic Timeline is an appropriate time that is
accurate and true to life.
• One of the main differences between those
who realize their goals and those who don't
seems to be the implementation of realistic
timeframes.
• No matter what type of goal you pursue,
setting a realistic timeline can help you realize
your goal.
Cont’d

• Setting a realistic timeline can be an excellent way

• to spur you to activity, to keep you on track,
• to help you avoid pitfalls (hidden or unsuspected
dangers or difficulties), and
• to achieve your goals with as little difficulty and
sacrifice as possible
Rules to Keep a Realistic Timeline
• 1. Create an Outline (a general plan)
• 2. Set Realistic Deadlines
• 3. Start on Time
• 4. Set Reminders
• 5. Start with the most time-consuming
Priorities
• Things that are considered to be more important than others
Cont’d
Performance Measures
• Performance measures quantitatively tell us something
important about our products, services, and processes
that produce them.
• They are tools to help us understand, manage, and
improve what our organizations do.
Performance measures let us know:
• How well we are doing
• If we are meeting our goals
• If our customers are satisfied
• If and where improvements are necessary
• They provide us with the information necessary to make
intelligent decisions about what we do.
Cont’d
• Performance measures are always tied to a goal or
an objective (the target).
• Most performance measures can be grouped into
one of the following six general categories.
• Effectiveness: A process characteristic indicating the
degree to which the process output (work product)
conforms to requirements. (Are we doing the right
things?)
• Efficiency: A process characteristic indicating the
degree to which the process produces the required
output at minimum resource cost. (Are we doing
things right?)
Cont’d
• Quality: The degree to which a product or service
meets customer requirements and expectations.
• Timeliness: Measures whether a unit of work was done
correctly and on time. Criteria must be established to
define what constitutes timeliness for a given unit of
work. The criterion is usually based on customer
requirements.
• Productivity: The value added by the process divided
by the value of the labor and capital consumed.
• Safety: Measures the overall health of the organization
and the working environment of its employees.
 Lo2. Monitor and manage work

2.1.Management and Its Functions

• Management is the act of getting people together to
accomplish desired goals and objectives.
• The person who performs this activity is known as
manager.
• Management functions are the activities that
managers are supposed to perform as result of the
position held in the organization.
 Regardless of the type and size of firms, all managers
have certain basic functions-planning, organizing,
staffing, leading and controlling.
 The scope and nature of these functions vary from one
management level to another and from firm to firm.
 Therefore; these functions are briefly described below.
Cont’d

Planning Organizing

Management Function ng
affi
St

Controlling Leading
 1. Planning Functions
Planning is the first and foremost function in
management. Also it is one of the fundamental and
pervasive of all functions.
 Planning is a process of establishing goals and a
suitable course of action for achieving these goals.
 It is a decision making process that determines what to
do, how to do it, why it is done, when it is to be done,
by whom it is to be done and with what resources.
 It serves as a bridge that connects the present with the
future as; in planning what should be done in the
future is determined today.
 It is a conscious determination of future actions.
2. Organizing Functions
Organizing is the process of distributing the
work among the group members and
establishing the relationships b/n them.
 It involves identification of activities to be
carried out, grouping these activities into
working units, assignment of responsibilities
to each unit with corresponding authority.
 It is also the process of combining and
integrating resources for achieving the
objectives.
3. Staffing Functions
Staffing is the process of ensuring that
employees are recruited, selected, trained,
and developed, and rewarded for
successful accomplishment of goals.
 It is a continuous and vital function of
management which involves filling and
keeping filled positions in a given
organizational structure.
 It is placing right person for right
position.
4. Leading/Directing Functions
Leading involves directing, influencing and
motivating employees to perform essential
tasks.
Leading is the action or implementation phase
which emanates from the planning and
organizing steps.
Leading encompasses three essential
elements: motivation, leadership and
communication and main function of leading is
producing other leaders by being role model.
5. Controlling Functions
Controlling is the measuring and correcting
of activities of subordinates to ensure that
events conform to plans or set standards.
 It measures performance against goals and
plans.
Controlling function involves the following
elements;
 Establishing standards of performance
 Measuring current performance
 Comparing performance to the established standards
 Taking corrective actions, if deviations are detected
 Management Skills
• The major skills required by a manager are
1. Conceptual skills
• Ability to see the “big picture” of the situation
• Ability to arrive at ideas
• Ability to create a vision and plan for the future
2. Technical Skills;-Possess specific knowledge or
have a specialized expertise
3. Human skills;-Ability to work well with others
both individually and in a group setting
2.2. Conducting Meeting

• Meeting is an assembly of people for a particular purpose, especially for

formal discussion.
Steps in conducting a meeting
• 1. Identify Goals and Objectives for the Meeting Before
the actual
• 2. Determine the Appropriate Participants meeting
• 3. Develop an Agenda

• 4. Review the Agenda and Ground Rules During

the actual
• 5. Allow Sufficient Time to facilitate the activities of meeting

the meeting from the beginning up to the end

•
6. Produce and Distribute a Meeting Summary After the
actual
• 7. Evaluate the Meeting meeting
2.3. Conflict Management
• Conflict:-It is a state of incompatibility of ideas between two
or more parties or individuals
• Conflict management is the practice of identifying and
handling conflict in a sensible, fair and efficient manner.
• General Causes of Conflicts
– Poorly defined goals
– Divergent personal values
– Lack of cooperation/trust
– Competition of scarce resources
– Unclear work roles/lack of job description
• Effects of Conflict in Organizations
– Stress
– Absenteeism
– Staff turnover
– De-motivation
– Non-productivity
Cont’d
• How to prevent Conflicts within a working team
– Frequent meeting of your team
– Allow your team to express openly
– Sharing objectives
– Having a clear and detailed job description
– Distributing task fairly
– Never criticize team members publicly
– Always be fair and just with your team members
– Being a role model for good work
• Conflict is unavoidable because of
– Complexity of organizational relationship
– Interaction among workers
– Dependence of workers on one another
– Conflict is a healthy sign not a negative process. Conflict
reflects dynamics (the forces which stimulate development or
change within a system or process)
Cont’d
• Healthy responses to conflict:
– The capacity to recognize and respond to the things that
matter to the other person
– Calm, non-defensive, and respectful reactions
– A readiness to forgive and forget, and to move past the
conflict without holding resentments or anger
• Unhealthy responses to conflict:
– An inability to recognize and respond to the things that
matter to the other person
– Explosive, angry, hurtful, and resentful reactions
– An inability to compromise or see the other person’s side
– The fear and avoidance of conflict; the expectation of bad
outcomes
– The ability to seek compromise and avoid punishing
– A belief that facing conflict head on is the best thing for
both sides
2.4. Information Management System (IMS)
• There is a distinction between data and information. The
information is a product of an analysis of data.
• This concept is similar to a raw material and the finished
product. What are needed are information and not a mass of
data.
• In many industries, survival and even existence is difficult
without extensive use of information technology.
• Information Management System (IMS) is a general term for
software designed to facilitate the storage, organization and
retrieval of information.
• The system was largely capable of handling the data from
collection to processing.
• Information systems have become essential for helping
organizations operate in a global economy..
2.4.Operation Management:-
• Operation can be described as that part of the
organization devoted to the production or delivery
of goods and services.
• It can be seen as of many functions (e.g. Marketing,
finance and personnel) within the organization.
• All organizations produce some mixture of services
and products, whether that organization is large or
small, manufacturing or service, for profit or not for
profit, public or private.
• Operation Management is the activity of managing
the operations of an organization.
 2.5.Resource Management

• Resources are all things of values for the organization that

are used in its day to day activities.
• Resource management is the process of using a company’s
resources in the most efficient way possible.
• These resources can include tangible resources such
as materials, equipment, machineries, financial resources,
and labor resources such as employees.
• Resource management can include ideas such
as making sure one has enough physical resources for
one's business,
• but not an over abundance so that products won't get
used, or making sure that people are assigned to tasks that
will keep them busy and not have too much downtime.
2.5.1.Human Resource Management
• Human resource management is the process of
reaching organizational goals by working with and
through people and other resources
Objectives of Human Resource Management
• Helping the organization reach its goals.
• Employing the skills and the abilities of the work force
efficiently.
• Increasing to the fullest to the employees’ job
satisfaction and self- actualization.
• Helping to maintain ethical policies and behavior.
• Managing change to the mutual advantage of
individuals, groups, the organization and the public.
Human Resource procurement process
• Job analysis is the systematic process of
determining the skills, duties and knowledge
required for performing jobs in an
organization.
• Human resource planning – assessing future
business needs, deciding on the numbers and
types of people required and preparing plans
for obtaining them from within or outside the
organization.
Recruitment and Selection
• Recruitment is the process of finding/inviting and
engaging the people for the organization needs.
• Selection is that part of the recruitment process
concerned with deciding which applicants or
candidates should be appointed to jobs.
Orientation and Training
• Orientation is the process of informing new
employees about what is expected of them in the
job and the organization and helping them with the
stresses of transition.
• Training is solely capacitating the human resource
on the current job
Training is important:
• To establish a sound relationship between the Worker
and his job-the optimum man-task relationship;
• To upgrade skills and prevent obsolescence.
• To develop healthy, constructive attitudes.
• To impart broad-based knowledge relating to the
plant, machinery, material, product, quality and
standards to factory, workplace and work
environment;
• To minimize operational errors and increase
productivity.
• To prepare employees for future assignments
• To enhance employee confidence and morale.
• To bring down costs of production.
Performance Appraisal and compensation
• Performance appraisal “is a systematic, periodic and an
impartial rating of an employee’s excellence in matters
pertaining to his present job and his potential for a better
job”.
• Compensation is the outcomes (rewards) employees receive
in exchange for their work.
The Process of Performance Appraisal
• Establishing performance standards
• Communicating the standards
• Measuring performance
• Comparing the actual with the standards
• Discussing the appraisal
• Taking corrective actions
Types of compensation
• Direct Financial Compensation consists of the
pay that a person receives in the form of wages,
salaries, bonuses, and commis­sions. For
example, you may receive direct financial
compensation in the form of paycheck.
• Indirect financial compensation (benefits)
includes all financial rewards that are not
included in direct compensation. You may again
receive indirect financial compensation because
the organization may pays 90 percent of all
medical and hospital costs.
Placement, Promotion, Demotion and
Termination
Placement
Placement refers to the assignment or
reassignment of an employee to a new job.
Employee placement is mainly decided jointly
by both the employee's immediate supervisor
and the top management.
Promotion
A promotion occurs when an employee is
moved from a job to another position that is
higher in pay, responsibility, and/or
organizational level.
Cont’d
Transfers and Demotions
• Transfers refer to reassignment of an employee
from one job to another position with similar
status, equal pay and/or responsibility.
• Demotions on the other hand, refer to the
downward movement of an employee.
Termination
• Termination is a permanent separation of an
employee from an organization. It may occur when
employees are fired, laid off, resign, retire or die.
2.6. Definition of Micro and Small
businesses in Ethiopia
• Micro: - Number of employees - less than or equal
to five (owner, family members and employed
employees)
• - Start-up capital excluding building:
• Service: Less than or equal to 50,000
• Industry: Less than or equal to 100,000
• Small: -Number of employees - 6 to 30 employees
(owner, family members and employed employees)
• - Start-up capital excluding building
• Service: 50,001 – 500,000
• Industry: 100,001 – 1, 500,000
2.7. Small Business Failure Factors
 External factors of failure
 economic business cycles
 fluctuating interest rates
 interrupted supplies
 labor market trends
 inflation.
 Personal factors of failure
 Inexperience: lack of technical skills and or management
expertise
 Arrogance: convinced beyond reason (often without market
research)
 Mismanagement: Over investment in fixed asset, Poor
inventory control and Poor financial control
 Lack of planning
Cont’d
 Incompetence-
 Unbalanced experience
 Lack of managerial experience
 Neglect /ignorant
 Fraud
Specific managerial failure factors
Inadequate records
Expansion beyond resource
Lack of information about customer
Lack of marketing research, technical competence,
One person management, nepotism and favoritism to
family members
 2.8. Key Success Factors in Setting up
a Small Business
• Idea and Market (the viability of the idea,
project, product or service to be offered)
• Ability (knowledge, technical or managerial
skills)
• Motivation and Determination
• Resources(Material & Human)
• Business plan
• Organization and Management
Lo3:-Develop effective work habits

3.1 Work Habits

• We humans are creatures of habit (a settled or regular
tendency or practice). Therefore, to develop good
habits should be simple - right! Well, not always.
• Seven Simple Steps to Develop Good Habits
1. Identify the habit.
2. Make the decision and the commitment to change
3. Discover your triggers (events that causes something
to happen) and obstacles
4. Devise a plan
5. Employ visualization and affirmations
6. Enlist support from family and friends
7. Find healthy ways to reward yourself.
Good Work Habits
• 1. Punctuality
• 2. Professionalism (the competence required of a professional)
• 3. Positive Attitude
• 4. Individuality (distinctive quality or character)
• 5. Diligence (careful and persistent work or effort)
• 6. Time Management
• 7. Organization
• 8. Energy (the strength and vitality required for sustained
activity)
• 9. Communication
• 10. Creativity
3.2 Work Prioritization & Time Mgt. Strategies
Work Prioritization
Prioritize your work by urgency of the task that
– Needs to be done now
– Should have been done yesterday
– Should be done today
– Can wait until tomorrow
– Can wait until time permits
• After prioritizing your work by urgency, it should then be prioritized
by the date it was received.
Time Management Strategies
• The term Time Management is a misnomer (the wrong use of name
or term). You cannot manage time; you manage the events in your
life in relation to time.
• Much like money, time is both valuable and limited: it must be
protected, used wisely, and budgeted.
• People who practice good time management techniques often find
Cont’d
– Are more productive,
– Have more energy for things they need to accomplish,
– Feel less stressed,
– Are able to do the things they want,
– Get more things done,
– Relate more positively to others, and
– Feel better about themselves
– Know how effectively to spend time
– Set priorities
– Use a planning tool
– Schedule time appropriately
– Delegate: get help from others
– Stop procrastinating
– Manage external time wasters
– Avoid multi-tasking
LO4 Interpret financial information

4.1. Financial statements analysis

What is financial analysis?
• Applying analytical techniques to financial
statements and other relevant data to produce
information useful for decision making.
• Who analyzes financial statements?
– Internal users (i.e., management)
– External users (i.e., investors, creditors, regulatory
agencies, stock market analysts and auditors)
• What do internal users use it for?
• Planning, evaluating and controlling enterprise
operations
What do external users use it for?
• Assessing past performance and current
financial position and making predictions
about the future profitability and solvency of
the company as well as evaluating the
effectiveness of management
• Information is available from
– Published annual reports
• Financial statements
• Letters to stockholders
• Auditor’s report (Independent accountants)
• Management’s discussion and analysis
Cont’d
– Reports filed with the government Example:
Import and export report
– Financial Statement Interpretation
• Information is available from
– Other sources
• Newspapers (e.g., Capital, Fortune)
• Periodicals
• Magazines (e.g. Brita,
• Financial information organizations such

as:
• Other business publications ( e.g. Business review,
Ratio Analysis
• Expression of logical relationships between items in a
financial statement of a single period (e.g., percentage
relationship between revenue and net income).
• An accounting ratio shows the mathematical relationship
between two figures, which have meaningful relation with
each other (e.g., percentage relationship between current
asset and current liability).
• Ratio is used as an index/directory for evaluating the
financial performance of the business concern.
A financial analyst uses the ratios to make two types of
comparisons:
• Industry comparison: The ratios of a firm are compared
with those of similar firms or with industry averages to
determine how the company is faring/operating relative to
its competitors.
Cont’d
• Trend analysis: A firm’s present ratio is compared
with its past and expected future ratios to
determine whether the company’s financial
condition is improving or deteriorating over time.
• Ratio can be classified into various types.
Classification from the point of view of financial
management is as follows:
• Liquidity/Short term Ratio
• Activity/Asset Utilization Ratio
• Solvency/Leverage/Debt Ratio
• Profitability Ratio
 1. Liquidity (Short term) Ratio
• Shows a firm’s ability to meet current liabilities with
its most liquid assets.
• Helps to understand the liquidity in a business
which is the potential ability to meet current
obligations/ short-term debt-paying ability
• Expresses the relationship between current assets
and current liabilities of the business concern
during a particular period.
• Current assets are those assets that are expected to
be converted into cash or used up within 1 year.
• Current liabilities are those liabilities that must be
paid within 1 year; they are paid out of current
assets.
Cont’d
• The following are the major liquidity ratio:
Working Capital:
• It is equal to current assets less current
liabilities.
• It is a safety cushion to creditors.
• Is calculated as:

Working capital =Current Assents – Current Liabilities

Cont’d
• The following are the major liquidity ratio:
Current Ratio (working capital ratio):
• is equal to current assets divided by current
liabilities.
• Measures the ability of an enterprise to meet
its current liabilities out of current assets.
• A high ratio is needed when the firm has
difficulty borrowing on short notice.
Current Assets
Current Ratio =
• Current Liabilities
The following are the major liquidity ratio:
Quick (Acid-Test) Ratio):
• Found by dividing the most liquid current assets
(cash, marketable securities, and accounts
receivable) by current liabilities.
• Inventory is not included because of the length of
time needed to convert inventory into cash.
• Prepaid expenses are also not included because
they are not convertible into cash and so are not
capable of covering current liabilities.
• It is calculated as:
Cash equivalents + Market securities + Net receivables
Acid Test Ratio =
Current Liabilities
 The following are the major liquidity ratio:
Cash Ratio:
• It is also known as doomsday ratio.
• The name doomsday ratio comes from the
worst case assumption that the business
ceases to exist and only the cash on hand is
available to meet credit obligations.
• It is calculated as:

Cash equivalents + Market securities

Cash Ratio =
Current Liabilities
2. Activity (Asset Utilization) Ratios

• Activity ratios are used to determine how quickly

various accounts are converted into sales or cash.
• As liquidity ratios do not give an adequate picture
of a company’s real liquidity (because of differences
in the kinds of current assets and liabilities the
company holds), it is necessary to evaluate the
activity or liquidity of specific current accounts.
• This ratio measures the efficiency of specific current
assets and liabilities in the business concern during
a particular period.
• Various ratios exist to measure the activity of
receivables, inventory, and total assets.
The following are the major activity ratios:
Accounts Receivable Ratios:
• Consist of the accounts receivable turnover ratio and
the average collection period (accounts receivable
turnover in days)
• The accounts receivable turnover ratio gives the
number of times accounts receivable is collected during
the year.
A/R turnover = Net sales/ Av. Account receivable
• The higher the accounts receivable turnover, the better
the performance.
• It is found by dividing net credit sales (if not available,
then total sales) by the average accounts receivable
365 days
Accounts receivable turnover in days = Receivable turnover
• .
The following are the major activity ratios:
Inventory Ratios:
• If a company is holding excess inventory,
• it means that funds which could be invested
elsewhere are being tied up in inventory,
• there will be high carrying cost for storing the
goods, and
• There will be risk of obsolescence.
• If inventory is too low, the company may lose
customers because it has run out of merchandise.
• Two major ratios for evaluating inventory are
inventory turnover and average age of inventory.
The following are the major activity ratios:
Inventory Ratios:
• The inventory turnover ratio measures how quickly
inventory is sold and it indicates enterprise
performance.
• The higher the turnover ratio, the better the
performance of the company.
• It is found by dividing cost of goods sold by average
inventory.
• However, Inventory turnover in days shows the
average no days a company takes to its inventory.
Cost of goods sold
Inventory turnover ratio =
Average inventory

Inventory Tot in days = 365/Inventory Tot

The following are the major activity ratios:
• Operating Cycle: of a business is the number of days
it takes to convert inventory and receivables to cash.
• It is found by adding average collection period and
average age of inventory together.
• This operating cycle indicates the number of days
between acquisition of inventory and realization of
cash from selling the inventory.
• A short operating cycle is desirable.

Operating cycle =AR turnover in days + Inventory

turnover in days
3. Leverage (Solvency, Long-Term Debt) Ratios

• Solvency is a company’s ability to meet its long-term

obligations as they become due.
• Its analysis concentrates on the long-term financial
and operating structure of the business.
• It is dependent upon profitability since in the long run
a firm will not be able to meet its debts unless it is
profitable.
• When debt is excessive, additional financing should be
obtained primarily from equity sources,
• Management might consider lengthening the maturity
of the debt and staggering the debt repayment dates.
• The following are the major solvency ratios:
Debt Ratio:
• Compares total liabilities (total debt) to total
assets.
• Shows the percentage of total funds obtained
from creditors.
• Creditors would rather see a low debt ratio
because there is a greater cushion for creditor
losses if the firm goes bankrupt.
• It is found by dividing total liabilities by total
assets. Total liabilities
Debt ratio = Total assets
Debt/Equity Ratio:
• It is a significant measure of solvency since a
high degree of debt in the capital structure
may make it difficult for the company to meet
interest charges and principal payments at
maturity.
• High debt position comes the risk of running
out of cash under conditions of adversity.
• Excessive debt will result in less financial
flexibility since the company will have greater
difficulty obtaining funds during a tight money
market.
Cont’d

• One of the major solvency ratios is:

Debt/Equity Ratio:
• The debt/equity ratio is computed as:
• This ratio indicates the degree of protection to
creditors in case of insolvency.
• The lower this ratio the better the company’s
position
Debt/Equity Total Liabilities
Ratio
4. Profitability Ratios
• An indication of good financial health and how
effectively the firm is being managed is the company’s
ability to earn a satisfactory profit and return on
investment.
• Investors will be reluctant to associate themselves
with an entity that has poor earning potential since
the market price of stock and dividend potential will
be adversely affected.
• Creditors will shy away from companies with deficient
profitability since the amounts owed to them may not
be paid.
• Absolute dollar profit by itself has little significance
unless it is related to its source.
Gross Profit Margin:

• Reveals the percentage of each dollar left over

after the business has paid for its goods.
• The higher the gross profit earned the better.
• Gross profit equals net sales less cost of goods
sold.
Gross Profit = Sales or Net Sales – Cost of Good Sold
• The gross profit margin is computed as:
Gross Profit
Gross profit margin =
Net sales
 Cont’d
• Some major ratios that measure operating results
are summarized below:
Net Profit Margin:
• Ratio of net income to net sales.
• Indicates the profitability generated from revenue
and it is an important measure of operating
performance.
• Provides clues to a company’s pricing, cost structure,
and production efficiency.
• The profit margin is computed as:
Net income
Profit margin =
Net sales
Cont’d
Return on Investment (ROI) :
• Measures the performance of a business entity
without regard to the method of financing.
• shows the extent to which earnings are
achieved on the investment made in the
business
• basically two ratios evaluate the return on
investment:
• Return on total assets (ROA)
• Return on owner’s equity
Cont’d
• Some major ratios that measure operating
results are summarized below:
• Return on Investment (ROI) :
• Return on total assets (ROA)
• Indicates the efficiency with which
management has used its available resources
to generate income.
• Return on total assets (ROA) is computed as:
Net income
Return on Total Assets =
Total Assets
Cont’d
• Some major ratios that measure operating
results are summarized below:
• Return on Investment (ROI) :
• Return on owner’s equity
• Measures the rate of return earned on the
common stockholders’ investment.
• The return on owner’s equity is computed as:
Net Profit After Tax
Return on Equity =
Stockholder’s Equity
Cont’d
• The financial statements of Motorola shown bellow as
an example
1) Balance Sheet
Assets
Cash………………………………………………………. Br. 9,000
Short-term Marketable securities ……….. 48,600
Accounts Receivable ……………………………. 351,200
Inventories………………………………………….. 715,200
Total Current Assets ……………………………. 1,124,000
Gross Fixed Assets……………………………….. 491,000
Less Accumulated Depreciation ………….. 146,200
Net Fixed Assets …………………………………. 344,800
Liability & Equity
Accounts payable……………………………….. Br. 145,600
Notes payable ……………………………………. 200,000
Accruals……………………………………………… 136,000
Total Current Liabilities ………………………. 481,600
Cont’d
Long Term Debt …………………………………… 323,432
Common Stock…………………………………….. 460,000
Retained Earnings ……………………………….. 203,768
Total Equity …………………………………………. 663,768
Total liabilities & Equity……………………….. 1,468,800

2) Income Statement
• Sales ……………………….. Br. 3,432,000
• Cost of Goods sold…… 2,864,000
• Other Expenses ………. 340,000
• Depreciation …………… 18,900
• Total Operating Costs… Br. 3,222,900
• Earning Before Int. & Tax 209,100
• Interest Expenses ………. 62,500
• Earning before Tax ……… 146,600
• Taxes (40%) ……………..... 58,640
• Net income ……………….. 87,960
Cont’d
• Based on the above information
calculate:-
1) Working capital, current ratio, Quick ratio &
Acid test ratio.
2) Debt ratio, Equity ratio, Time interest earned.
3) Accounts Receivable tot ratio, Inventory ratio,
Inventory tot in days , Operating cycle.
4) Gross profit margin, Profit margin, ROI(ROA),
Return Equity?
 Answers

1) Liquidity ratio
• a) Working Capital = Current assets – Current liabilities
• = 1,124,000 – 481,600 = 642,400
• b) Current ratio = Current assets/ Current liabilities
• = 1,124,000/ 481,600 = 2.34 times
• c) Quick ratio = Cash Equiv. + Market Secu. + Net receivable
• Current liabilities
• = 9,000 + 48,600 + 351,200/ 481,600
• = 408,800/481,600 = 0.85 times
• d) Cash ratio = Cash Equiv. + Market Secu. / Current
liabilities
• = 9000 + 48,600/ 481,600
• = 57600/481600 = 0.12 times
2)Debt ratio/Solvency/ Leverage

• a) Debt ratio = Total liabilities / Total assets

• = 481,600 + 323,432 / 1,468,800
• = 805,032/1,468,800 = 0.55= 55%
• b) Equity ratio = Total liab./ stock hold.
equity
• = 805,032/663,768 = 1.21=121%
3) Activity ratio

A/R turnover = Net sales/ Av. Account receivable

= 3,432,000/351,200 = 9.8 times
• a) A/R tot in days = 365/ Av. Receivable turnover
• = 365/ 9.77 = 37.36 days
• b) Inventory turnover = CGS/Average inventory
• = 2,864,000 / 751,200 = 3.8 times
• c) Inventory tot in days = 365/inv. Tot = 365/ 3.81
= 96.6 days
• d) Operating cycle = A/R tot in days + inv. Tot in
days
• = 37.36 + 96.59 = 134 days
Cont’d
4) Profitability ratio
a) gross profit margin = gross profit/net ales
= 3,432,000 - 2,864,000 / 3,432,000
= 568000 / 3,432,000= 0.17=17%
b) Profit margin = Net profit/ net sales
= 87,960/3,432,000 = 0.03=3%
c) ROI(A) = Net profit / Total assets
= 87,960/1,468,800 = 0.06= 6%
d)ROE = Net profit / stock holders’ equity
= 87,960 / 663,768 = 0.13=13%
 Cont’d

Summary
• Liquidity ability to meet short terms obligations
• Activity ability to collect accounts receivable
and pay payables
• Or, ability to determine the salability of
products.
• Leverage ability to meet long term obligations
• Operating performance (profitability ratio):-
profitability through regular operations.
Financial ratios of Motorola from the
industry
Motorola Industry
• Current ratio (less) 1.77 2.44
• Quick ratio (less) 1.47 2.08
• Average collec. period (lower) 50 days 61 days
• Inventory turnover 6.25 6.01
• Debt ratio 0.64 0.34
• Debt to equity ratio 1.77 0.52
• GP margin 32.76% 37.49%
• Np margin -9.31% -3.0%
• ROI -7.98% -1.82%
• RO Equity
• Assets/ Equity
Financial Comparisons of Motorola to the Industry

• Motorola collects receivables quicker than the

average firm.
• Motorola should evaluate the credit policies.
• Total assets Tot are above the industry
(effective use of assets)
• Motorola is more leveraged than the average
industry. It is poor financial performance.
End