3.5 Flashcards
What does Gross Profit Margin measure?
It is a profitability ratio that measures an organization’s gross profit expressed as a percentage of its sales revenue. It is also an indicator of how well a business can manage its direct costs of production.
How to improve a Gross Profit Margin?
- Better the firm’s promotional strategies
- Launching new goods and/or services that have a higher gross profit margin
- Outsourcing production or other operations to third-party suppliers.
What does the Profit Margin measure?
Measures a firm’s overall profit (after all costs of production have been deducted) as a percentage of its sales revenue. It is also an indicator of how well a business can manage its indirect costs (overhead expenses).
What is Return on Capital Employed? (ROCE)
It measures a firm’s efficiency and profitability in relation to its size (as measured by the value of the organization’s capital employed).
Capital employed is the value of the funds used to operate the business and to generate a financial return for the organization. It is the sum of non-current liabilities and equity finance.
How to Improve ROCE?
- Increasing the firm’s sales revenues by using strategies such as reduced prices to attract more customers, using new sales promotions.
- Reduce costs of production through methods such as using alternative suppliers, having improved stock control systems.
- Selling unproductive, unused, underused, and obsolete assets in order to improve operational efficiency and liquidity
What does the Current Ratio measure?
Calculates the ability of an organization to meet its short-term debts (within the next twelve months of the balance sheet date). It calculates the value of an organization’s liquid assets relative to its short-term liabilities.
How to improve current ratio?
- Attract more customers, perhaps by changing the pricing strategy and/or improving its promotional strategies.
- Encourage customers to pay by cash, thereby improving the firm’s cash inflows.
- Use any available cash to pay off short-term debts, thereby reducing the interest (debt) burden on the business in the long run.
- Negotiate with suppliers for an extended trade credit period, thereby improving its own liquidity position.
What does the acid test (quick ratio) measure?
Measures an organization’s ability to pay its short-term debts (within the next twelve months of the balance sheet date), without the need to sell any stock (inventories).
How to improve acid test?
- Use the same methods that improve the current ratio
- Improve its stock control management system in order to reduce the cash outflows associated with poor stock control management. This is because the value of a firm’s acid test ratio improves as its level of stocks (inventories) falls.
