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Accounting > Profitability ratios > Flashcards

Profitability ratios Flashcards

1
Q

What do profitability ratios measure?

A

How well are revenues converted into profits?

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2
Q

What are the two types of profitability ratio?

A
  1. Profit margin ratios
  2. Return ratios
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3
Q

What are the three main profit margin ratios?

A
  1. Gross profit margin
  2. Operating profit margin
  3. Net profit margin
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4
Q

What is the formula for gross profit margin?

A

gross profit / sales revenue x 100

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5
Q

What is the formula for operating profit margin?

A

operating profit / sales revenue x 100

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6
Q

What is the formula for net profit margin?

A

net profit / sales revenue x 100

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7
Q

What is the relationship between gross profit margin and cost of goods sold?

A

gross profit margin + CoGS as a % of revenue = 100%

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8
Q

What is the relationship between operating profit margin and operating expenses?

A

operating profit margin + OpEx as a % of revenue = gross profit margin

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9
Q

What can the relationship between different profit margins tell us?

A

Whether increased profit is driven by reduced CoGS or OpEx

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10
Q

What are the three main return ratios?

A
  1. Return on capital employed (ROCE)
  2. Return on equity (ROE)
  3. Return on assets (ROA)
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11
Q

What does ROCE stand for?

A

Return on capital employed

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12
Q

What does ROE stand for?

A

Return on equity

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13
Q

What does ROA stand for?

A

Return on assets

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14
Q

What is the formula for ROCE?

A

operating profit / capital employed x 100

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15
Q

What is the primary measure of profitability?

A

ROCE

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16
Q

What is the formula for ROE?

A

net profit / equity x 100

17
Q

What is the most relevant ratio for shareholders?

A

ROE

18
Q

What is the formula for ROA?

A

net profit / assets x 100

19
Q

What is “capital employed”?

A

Long-term capital available for business activities

20
Q

How is “capital employed” calculated?

A

equity + non-current liabilities OR
total assets - current liabilities

21
Q

What is sometimes used in the ROCE formula in place of operating profit?

A

EBIT (earnings before interest and tax)

22
Q

How is EBIT calculated?

A

net profit + interest expense + tax

23
Q

What is the difference between operating profit and EBIT?

A

EBIT includes non-operating gains / losses e.g. interest, disposal of assets

24
Q

When is ROA most useful?

A

When comparing firms with different capital structures (high equity vs high liabilities)

25
Q

When is ROE most useful?

A

When analysing stable, established companies with high equity

Accounting (13 decks)

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