Topic 10: Ratios

Question 1

What is the definition of Profitability?

Answer 1

The ability of a business to control its expenses to earn a profit.

Question 2

What is the definition of the Profit (Margin) Ratio?

Answer 2

The percentage of profit (after tax) that is contained in each dollar of sales.

Question 3

What is the trend in the Profit (Margin) Ratio when it Increases?

Answer 3

An increase in profit in proportion to sales.

Question 4

What is the trend in the Profit (Margin) Ratio when it Decreases?

Answer 4

A decrease in profit in proportion to sales.

Question 5

What are some reasons behind an Increase in the Profit (Margin) Ratio?

Answer 5

• decrease in expenses
• increase in selling price
• decrease in cost of sales

Question 6

What are some reasons behind a Decrease in the Profit (Margin) Ratio?

Answer 6

• increase in expenses
• decrease in selling price
• increase in cost of sales

Question 7

What are some suggested strategies for improving the Profit (Margin) Ratio?

Answer 7

• decrease expenses
• increase selling price
• decrease cost of sales / find cheaper suppliers

Question 8

What is the definition of the Gross Profit Ratio?

Answer 8

The percentage of profit the business has earned from its inventory.

Question 9

What is the trend in the Gross Profit Ratio when it Increases?

Answer 9

An increase in gross profit in proportion to sales.

Question 10

What is the trend in the Gross Profit Ratio when it Decreases?

Answer 10

A decrease in gross profit in proportion to sales.

Question 11

What are some reasons behind an Increase in the Gross Profit Ratio?

Answer 11

• increase in selling price
• selling more high profit items
• decrease in cost of sales

Question 12

What are some reasons behind an Decrease in the Gross Profit Ratio?

Answer 12

• decrease in selling price
• selling more low profit items
• increase in cost of sales

Question 13

What are some suggested strategies for improving the Gross Profit Ratio?

Answer 13

• increase selling price
• decrease cost of sales / find cheaper suppliers

Question 14

What is the definition of the Expense Ratio?

Answer 14

The percentage of expenses (exc. cost of sales) that is contained with each dollar of sales.

Question 15

What is the trend in the Expense Ratio when it Increases?

Answer 15

An increase in expenses in proportion to sales.

Question 16

What is the trend in the Expense Ratio when it Decreases?

Answer 16

A decrease in expenses in proportion to sales.

Question 17

What are some reasons behind an Increase in the Expense Ratio?

Answer 17

• increase in expenses
• inclusion of an extra-ordinary expense

Question 18

What are some reasons behind a Decrease in the Expense Ratio?

Answer 18

• decrease in expenses

Question 19

What are some suggested strategies for improving the Expense Ratio?

Answer 19

• increase profit through increasing sales while maintaining expenses
• decrease expenses

Question 20

What is the definition of the Rate of Return on Assets Ratio?

Answer 20

How efficiently a business has used its assets to generate a profit.

Question 21

What is the trend in the Rate of Return on Assets Ratio when it’s High?

Answer 21

Good performance of assets or effective use of assets to generate profit.

Question 22

What is the trend in the Rate of Return on Assets Ratio when it’s Low?

Answer 22

Poor performance of assets/non-effective use of assets to generate profit.

Question 23

What are some reasons behind an Increase in the Rate of Return on Assets Ratio?

Answer 23

• increase in sales
• decrease in expenses
• decrease in total assets

Question 24

What are some reasons behind a Decrease in the Rate of Return on Assets Ratio?

Answer 24

• decrease in sales
• increase in expenses
• increase in total assets

Question 25

What are some suggested strategies for improving the Rate of Return on Assets Ratio?

Answer 25

- increase profitability by better control of expenses - better use of assets

Question 26

What is the definition of Liquidity?

Answer 26

How easy it is to turn assets into cash in order to pay debts as they fall due.

Question 27

What is the definition of the Current Ratio?

Answer 27

The ability to pay off short term debts (less than 12 months) using current assets.

Question 28

What is the trend in the Current Ratio when it is below 100%?

Answer 28

It will be difficult to pay off debts.

Question 29

What is the trend in the Current Ratio when it is between 100% and 200%?

Answer 29

Should be easy to pay off debts (ideal/safe).

Question 30

What is the trend in the Current Ratio when it is above 200%?

Answer 30

It is easy to pay off but current assets are not being used efficiently.

Question 31

What are some suggested strategies for improving the Current Ratio?

Answer 31

- better credit policy (improve acc. rec.) - improve stock turn-over (decrease inventory) - monitor expenses - pay back acc. payable - reduce short term loans

Question 32

What is the definition of the Quick Asset Ratio?

Answer 32

The ability to meet immediate debts using very liquid assets.

Question 33

What is the trend in the Quick Asset Ratio when it is below 100%?

Answer 33

Should be able to pay off debts.

Question 34

What is the trend in the Quick Asset Ratio when it is above 100%?

Answer 34

Will find it difficult to pay off debts.

Question 35

What are some suggested strategies for improving the Quick Asset Ratio?

Answer 35

- better credit policy (improve acc. rec.) - improve stock turn-over (decrease inventory) - monitor expenses - pay back acc. payable - reduce short term loans

Question 36

What is the definition of Leverage?

Answer 36

The amount of borrowings of a business.

Question 37

What is the definition of the Debt to Equity Ratio?

Answer 37

Compares how much a company borrows externally compared to how much they borrow internally.

Question 38

What is the trend in the Debt to Equity Ratio when it is above 100% (high)?

Answer 38

Reliant on external finance which can cause concern as we have to pay interest payments.

Question 39

What is the trend in the Debt to Equity Ratio when it is below 100% (low)?

Answer 39

Not too reliant on external finance so will be able to pay off easily.

Question 40

What are some reasons behind an Increase in the Debt to Equity Ratio?

Answer 40

Not necessarily bad because even though we pay interest, the borrowed funds can be used to expand operations (higher growth and sales).

Question 41

What are some reasons behind a Decrease in the Debt to Equity Ratio?

Answer 41

Typically a good sign because less risk (manage interest payments) but the future growth of the business can slow down because there is a lack of expansion.

Question 42

What are some suggested strategies for improving the Debt to Equity Ratio?

Answer 42

- increase capital contributions - decrease drawings - refinance or find loans with lower interest rates - reinvest profits

Question 43

What are three different limitations to ratio analysis?

Answer 43

Historic Focus not Future Focus: ratios reflect historic performance and do not predict future performance Need for Comparison: ratios need to be compared with other information to be most useful Data Manipulation: data could me manipulated to make data appear more desirable. This will impact ratio calculations & comparisons.

Question 44

What are some things Ratios can be compared with?

Answer 44

- budgeted/predicted results - previous years results - industry averages - other businesses