Lesson plan 17

Module: Finance

Topic: Financial Ratio Analysis

Year: 11

Period: one hour

Ability: mixed

Aim: help students to understand how profitability ratio analysis helps to assess
business profitability.

Objectives of the lesson:

to understand the meaning of % net profit;

to understand the meaning of % of gross profit;
to learn how to calculate ratios;
to understand how businesses can improve their profitability;
to analyse and investigate business actions used to improve their profitability;
to appreciate the interdependence of different functional areas in a business.

Phase 1 Introduction 5-7 minutes

1. State clearly the objectives of the lesson.

2. Link the new topic to students’ prior learning about how businesses are structured
and its functional areas.

Phase 2 Development 45-50 minutes

Stage 1 how to use ratios 5 minutes

The profitability ratio diagram

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 Assessing a business
profitability

Profit & loss

Trading account
account

Gross profit Net profit

% gross % net
profit profit

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 How to use ratios in the exam

Comparing
ratios
Interpreting
ratios

Calculating ratios

Obtaining data –which account?

Stage 2 obtaining the data – which account?

Activity “Where do I belong?” 7-10 minutes

First, individually students are going to carry out this activity, and then have it
discussed with by whole class.

Stage 3 calculations of ratios

% Gross profit and % net profit

1. % Gross profit

Remember

Sales Revenue – Cost of Sales = Gross profit/loss

1. Look closely at the following formula

Gross profit

-------------------------- X100 =Gross profit margin

Sales revenue/turnover

For example, at the end of 2002, Roberts Ltd’s gross profit was £1000 and its sales
revenue was £10,000, therefore its % gross profit is 10%.

The higher this ratio is the better it is.

2. % Net profit
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 Remember

Gross profit – other expenses + other sources of income = net profit

Look closely at the following formula

Net profit

-------------------------- X100 = Net profit margin

Sales revenue/turnover

For example, if Roberts Ltd net profit at the end of 2002 was £500 and its sales
revenue was £10,000, then its % net profit is 5%.

Stage 4 Interpretations of ratios

In the above example Robert Ltd’s % gross profit and % net profit were 10% and 5%,
which indicate that the business profitability is poor/low.

The higher the ratios are the better the business profitability position.

Stage 5 comparisons of ratios

Look at Roberts Ltd’s % gross profit and % net profit over a period of time.

Year 1998 1999 2000 2001 2002

% gross 45% 35% 25% 15% 10%
profit
% net profit 30% 20% 15% 10% 5%

Comparison means working out a trend over a period of time.

Stage 6 Suggestions to improve gross profit margin (reflection)

Scenario 1

James Woods sells quality dinning table furniture. At the end of 2002 the gross profit
James Wood business was £10,000, and the total sales revenue was £100,000.

3. Work out James Woods’ Gross Profit Margin at the end of the year.

4. Suggest how James could improve his percentage gross profit.

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 5. Choose the right strategies from the ones below and explain your reasons in
the table below.

 Improve James Woods’ Advertising Strategy

 Use less heating
 Launch a new marketing campaign
 Move to a cheaper location
 Reduce cost of sales
 Improve the quality of furniture.
 Buy cheaper raw materials
 Employ less workforce
 Use better below the line promotion
 Use better technology
 Reduce wastages in raw materials
 Increase the selling price

6. Students are going to be encouraged to come up with suggestions to improve

% gross profit or gross profit margin. For a few minutes students are going to
work individually to suggest ways to improve James Woods’ gross profit
margin. This will be followed by a whole group discussion.

Strategies to improve % Reasons

gross profit

Scenario 2
If James Woods’ other expenses in 2002 were as follows:
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Wages £2000
Heating and lighting £1000
Transportation £500
Advertising £500
Depreciation £300
Bad debts £700
Insurance £500
Rent £ 2500

1. Work out James Woods’ Net Profit Margin at the end of the year.

2. Compare James’s % net profit with his percentage gross profit.

3. Suggest how James could improve his percentage net profit.

4. Choose the right strategies from the ones above and explain your reasons in
the table below.

Strategies to improve % net Reasons

profit

Phase 4 Home work/conclusion and end 5 minutes

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 Where Do I belong?

Fill in the empty gaps in the table below.

Information figure/ratio I belong to …………….

Sales revenue

Gross profit

Net profit

Operating profit

Net profit margin

Gross profit margin

Capital/ assets employed

Cost of Stock

Current assets

Current liabilities
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Working capital

Dividends

Retained profit

Depreciation

Wages

Bad debts

Tax

Answer Sheet
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Information figure/ratio I belong to …………….
Sales revenue Profit and loss account (trading
account)
Gross profit Profit and loss account (trading
account)
Net profit Profit and loss account
Operating profit Profit and loss account
Net profit margin Profit and loss account
Gross profit margin Profit and loss account (trading
account)
Capital/ assets employed Balance sheet (long term
liabilities)
Stock Profit and loss account (trading
account) Balance sheet.
Current assets Balance sheet
Current liabilities Balance sheet
Working capital Balance sheet
Dividends Profit and loss
Balance sheet (liabilities)
Retained profit Profit and loss and balance sheet
Depreciation Profit and loss account
Wages Profit and loss account
Bad debts Profit and loss account
Tax Profit and loss account

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Activity

Scenario 1

James Woods sells quality dinning table furniture. At the end

of 2002 the gross profit for James Woods’ business was
£10,000, and the total sales revenue was £100,000.

7. Work out James Woods’ Gross Profit Margin at the end of the year.

8. Suggest how James could improve his percentage gross profit.

9. Choose the right strategies from the ones below and explain your reasons in
the table below.

 Improve James Woods’ Advertising Strategy

 Use less heating
 Launch a new marketing campaign
 Move to a cheaper location
 Reduce cost of sales
 Improve the quality of furniture
 Buy cheaper raw materials
 Employ less workforce
 Use better below the line promotion
 Use better technology
 Reduce wastages in raw materials
 Increase the selling price

10. Come up with suggestions to improve % gross profit or gross profit margin.
For few minutes students are going to work individually to suggest ways to
improve James Wood gross profit margin. This will be followed by a whole
group discussion.

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 Strategies to improve % Reasons
gross profit

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Scenario 2

If James Woods’ other expenses in 2002 were as follows:

Wages £2000
Heating and lighting £1000
Transportation £500
Advertising £500
Depreciation £300
Bad debts £700
Insurance £500
Rent £ 2500

5. Work out James Woods’ Net Profit Margin at the end of the year.

6. Compare James % net profit with his percentage gross profit.

7. Suggest how James could improve his percentage net profit.

8. Choose the right strategies from the ones above and explain your reasons in
the attached table.

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 Strategies to improve % net Reasons
profit

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