ratios

Question 1

what are the three profitability ratios?

Answer 1

• Gross Profit Percentage Ratio
• Profit for the Year Percentage
• Return on Equity Employed

Question 2

what does the Gross Profit Percentage Ratio do?
what is the formula?
what are two ways of improving it?

Answer 2

• works out the amount of profit from the buying and selling of goods before all other expenses are deducted
• (Gross Profit/Sales Revenue) x 100
• raise the selling price of the product, negotiate deals with less expensive suppliers

Question 3

what does the Profit for the Year Percentage ratio do?
what is the formula?
what are two ways of improving it?

Answer 3

• works out the amount of profit made once all expenses are deducted
• (Profit for the Year/Sales Revenue) x 100
• decrease expenses, for example finding cheaper premises to rent, increase the gross profit figure

Question 4

what does the Return on Equity Employed ratio do?
what is the formula?
what are two ways of improving it?

Answer 4

• calculates how much money an investor will get back after a period of time, often used by venture capitalists
• (Profit for the Year/Opening Equity) x 100
• increase sales, reduce expenses

Question 5

what are the two liquidity ratios?

Answer 5

• Current ratio
• Acid test ratio

Question 6

what does the current ratio do?
what is the formula?
what is the ideal ratio?
what are two ways of improving it?

Answer 6

• demonstrates the firms ability to meet its short-term creditors
• current assets: current liabilities
• 2:1, 4:1 it could meanfirm is inefficient and has too much money tied up in stock, 1:1 would mean that it may not be able to meet its debts quickly
• increase current assets, if ratio is too high you can sell non-current assets

Question 7

what does the acid test ratio do?
what is the formula?
what is the ideal ratio?

Answer 7

• a more severe test of a firm’s capabilities to meet its debts
• (current assets – closing inventory): current liabilitie
• 1:1

Question 8

what is the efficiency ratio?

Answer 8

Rate of inventory turnover

Question 9

what does the Rate of inventory turnover ratio do?
what is the formula?

Answer 9

• efficiency ratio which determines how quickly a firm goes through its stock
• Cost of sales:Average inventory

Question 10

what are the four purposes of ratio analysis?

Answer 10

• help compare current performance with previous records
• help compare a firm’s performance with similar competitors
• help monitor and identify issues that can be highlighted and resolved
• help with future decision making

Question 11

what are the four limitations of ratio analysis?

Answer 11

• information is historic – it is not current
• does not take into account external factors such as a worldwide recession
• does not measure the human element of a firm
• can only be used for comparison with other firms of the same size and type