Profitability and performance ratios

Question 1

profitability ratios definition

Answer 1

measure the relationship between gross/net profit and sales

Question 2

gross profit definition

Answer 2

ratio that calculates the amount of gross profit made from each £ of sales revenue

basically how much revenue makes it through to gross profit after variable costs have been deducted

Question 3

gross profit margin calculation

Answer 3

gross profit / sales revenue x 100

Question 4

3 ways to improve gross profit margin

Answer 4

• raiseing sales revenue whilst keeping the costs of sales the same
• reducing the cost of sales whilst maintaining the same level of sales revenue
• trying to add more value

Question 5

operating profit margin definition

Answer 5

measures the extent to which sales revenue is converted into operating (net) profit

or how much of the revenue avoids be used up on costs

Question 6

operating profit calculation

Answer 6

operating profit / sales revenue x 100

Question 7

whats a benefit of combining both the operating profit margin and the gross profit margin

Answer 7

builds a clear picture of where the businesses costs are
- illustrates the extent to which the business is controlling its overheads (fixed costs)
- the difference between the GPM and OPM is the percentage of fixed costs

Question 8

2 ways to improve the Operating profit margin

Answer 8

• raising sales revenue whilst keeping expenses low
• reducing expenses whilst maintaining the same level of sales revenue

Question 9

Return on capital employed (ROCE) definition

Answer 9

measures the efficiency with which the firm generates profits from the funds invested in the business (whether borrowed or from the owners)

• also known as primary efficiency ratio and is the most important ratio of all

Question 10

what key question does return on capital employed answer

Answer 10

what annual percentage return would i get on my capital

Question 11

return on capital employed calculation

Answer 11

operating (net) profit / capital employed x 100

Question 12

capital employed calculation

Answer 12

= non current liabilities + total equity

Question 13

3 ways to improve return on capital employed

Answer 13

• increasing the level of profit generated by the same level of capital employed
• be busy (high capacity utilisation)
• maintaining the level of profits generated but decreasing the amount of capital it takes to do so
• easiest and most efficient one is high capacity utilsation

Question 14

what are 4 types of business ratios

Answer 14

• profitability ratios
• liquidity ratios
• gearing ratios
• efficiency ratios

Question 15

what is a liquidity ratio

Answer 15

measures the ability of the business to settle its debts in the short term

Question 16

what is a gearing ratio

Answer 16

examines the relationship between internal and external sources of finance

it is concerned with the long term financial position of the company