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Close
Corporation (CC) Ratio and Analysis
Just like
sole traders, partnerships
and other forms of business
ownership, the members or owners that invest
money
will expect returns on their investments. The ratios that are related
to a CC are the return on members equity, debt : equity ratio and the
return on total capital employed.
The ratios will be discussed in detail below:
Return Earned
By Members
Members
invest their money into the CC with the goal of earning a return on
their contribution. CC members
invest in the CC through member’s
contributions, retained income that has been left in the CC and also in
the form of loans to the Close Corporation.
The return earned by members in calculated by taking the net profit
after tax plus the interest on loans to the CC.
As
with other business and investment options, members will compare their
earnings from the CC to other investment opportunities.
Debt : Equity
Ratio
The
debt to equity ratio is used to determine the risk of the business
which is the amount invested from outside sources to what the members
have invested. Remember that loans from members will be added to the
equity.
To determine the position of the business you will need the following
guidelines:
- Ratio
of less than 1 = Low risk
- Ratio
of more than 1 = High risk
There
is nothing wrong with high risk as long as the return earned is
positive, but always analyze the investment from all angles
and
get advice before making drastic decisions.
Return on
Total Capital Employed
This
ratio is used to measure if the capital in the business is working for
the business or not. It is important that all businesses aim for
positive gearing (a return higher than current interest on the loan in
the long term) otherwise the business will run into problems such as
cash flow problems, etc.
Summary of
Close Corporation (CC) Ratios
1.) Return on Member's Equity:
Net Profit after tax +
interest on loans
Average equity + loans from members |
X |
100
1 |
Reason: Measures whether the CC is a viable investment option for
members.
2.)
Debt : Equity Ratio
| External
loans : Members Equity + Loans from members |
Reason: Measures the risk of the CC
3.) Return on Total Capital Employed
Net profit after tax+
Interest on Loan (ext) + Interest on loans (members)
Average
Equity + Loans (ext) + Loans from members
|
X |
100
1 |
Reason: Measures whether loaning money is a viable financial decision.
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