Unit 3.5 Profitability and liquidity ratio analysis

Question 1

acid test ratio

Answer 1

The acid test ratio (or quick ratio) is a liquidity ratio that measures a firm’s ability to meet its short-term debts. It ignores stock because not all inventories can be easily turned into cash in a short time frame.

Question 2

Capital employed

Answer 2

Capital employed is the value of all long-term sources of finance for a business, namely noncurrent liabilities plus equity.

Question 3

current ratio

Answer 3

The current ratio is a short-term liquidity ratio that calculates the ability of a business to meet its debts within the next twelve months.

Question 4

gross profit margin (GPM)

Answer 4

The gross profit margin (GPM) is a profitability ratio that shows the value of a firm’s gross profit expressed as a percentage of its sales revenue.

Question 5

Liquid assets

Answer 5

Liquid assets are the possessions of a business that can be turned into cash quickly without losing their value, i.e. cash, stocks and debtors.

Question 6

Liquidity crisis

Answer 6

Liquidity crisis refers to a situation where a firm is unable to pay its short-term debts, i.e. current liabilities exceed current assets.

Question 7

Liquidity ratios

Answer 7

Liquidity ratios look at the ability of a firm to pay its short- term (current) liabilities, comprised of the current ratio and the acid test (quick) ratio.

Question 8

profit margin

Answer 8

The profit margin is a ratio that shows the percentage of sales revenue that turns into profit, i.e. the proportion of sales revenue left over after all direct and indirect costs have been paid.

Question 9

Profitability ratios

Answer 9

Profitability ratios examine profit in relation to other figures, comprised of the gross profit margin (GPM), profit margin and return on capital employed (ROCE) ratios.

Question 10

Ratio analysis

Answer 10

Ratio analysis is a quantitative management tool that compares different financial figures to examine and judge the financial performance of a business.

Question 11

return on capital employed (ROCE)

Answer 11

The return on capital employed (ROCE) is a profitability ratio that measures the financial performance of a firm based on the amount of capital invested.

Question 12

Gross Profit Margin (profitability)

Answer 12

gross profit/sales revenue x100

Question 13

profit margin (profitability)

Answer 13

profit before interest and tax/ sales revenue x 100

Question 14

current ratio ( liquidity)

Answer 14

current assets / current liabilities

Question 15

acid test ( liquidity)

Answer 15

current assets - stock/ current liabilities x 100

Question 16

return on capital employed (profitability)

Answer 16

net profit before interest and tax/ capital employed x100

Question 17

order of assets and liabilities sheet

Answer 17

-= non current assets
- current assets (cash/debtors/stock)
- total assets
- current liabilities
- total assets less current liabilities
- non current liabilities
-total liabilities
- net assets
- share capital
-retained profit
- equity