3.5 profitability and liquidity Flashcards
(21 cards)
What is ratio analysis?
A technique for analyzing a business’s financial performance by comparing one piece of accounting information with another.
How is profitability expressed in relation to sales?
Profitability can be expressed as a percentage of sales, showing the profit relative to total sales.
What are profitability ratios?
Ratios that assess the amount of gross or other profit made by the business in relation to turnover, assets, or capital.
What are liquidity ratios?
Also known as solvency ratios, these measure the ability of a business to settle its debts in the short-term.
What factors should be considered when analyzing ratios?
The financial performance over recent years, industry norms or benchmarks, and data on the economic environment.
What is the gross profit margin (GPM)?
A profitability ratio that measures an organization’s gross profit as a percentage of its sales revenue.
How is the gross profit margin calculated?
GPM = (Gross Profit / Sales Revenue) × 100.
What is the profit margin ratio?
A profitability ratio that measures overall profit as a percentage of sales revenue after all costs have been deducted.
How is the profit margin calculated?
Profit Margin = (Profit / Sales Revenue) × 100.
What does the return on capital employed (ROCE) measure?
ROCE measures a firm’s efficiency and profitability in relation to its size, as indicated by the capital employed.
How is ROCE calculated?
ROCE = (Profit before interest and tax / Capital employed) × 100.
What strategies can improve ROCE?
Boosting sales, cutting production costs, and improving efficiency and liquidity.
What is the current ratio?
A short-term liquidity ratio that calculates the ability of an organization to meet its short-term debts.
How is the current ratio calculated?
Current Ratio = Current Assets / Current Liabilities.
What is the acid test ratio?
Also known as the quick ratio, it measures the ability to pay short-term debts without selling stock.
How is the acid test ratio calculated?
Acid Test Ratio = (Current Assets - Stock) / Current Liabilities.
What is a key factor in improving the current ratio?
Increasing liquid assets or reducing short-term liabilities.
What is a key factor in improving the acid test ratio?
Reducing current liabilities or increasing current assets, excluding stock.
What is the significance of tracking ratio trends over time?
It helps interpret data and can indicate positive developments even if ratios are low.
Why should ratio results be compared to industry norms?
To assess performance relative to competitors and understand acceptable levels for specific sectors.
How can economic conditions affect profitability ratios?
A decline in profitability ratios may be more acceptable during economic recessions.
