3.5 Flashcards
What is ratio analysis?
A quantitative management tool that compares different financial figures to examine the financial performance of a business.
What is the purpose of ratio analysis?
To assess financial position, evaluate performance, compare actual figures with budgeted figures, and aid decision-making.
What are profitability ratios?
Ratios that examine profit at a firm compared to its financials, including gross profit margin, profit margin, and return on capital employed.
What does a higher gross profit margin (GPM) indicate?
It indicates better financial performance for the firm.
What are the main profitability ratios?
- Gross Profit Margin (GPM)
- Profit Margin (P)
- Return on Capital Employed (ROCE)
What is the limitation of profitability ratios?
They only apply to profit-focused firms.
Fill in the blank: Ratio analysis is a _______ management tool.
quantitative
What does ratio analysis help managers assess over time?
Financial performance.
What is a key benefit of comparing actual figures with budgeted figures in ratio analysis?
Variance analysis to improve financial management.
What is a strategy for improving sales according to the text?
Raising prices if there is high brand loyalty
This can lead to higher sales revenue.
What is a method for lowering prices?
Using marketing strategies such as special promotions and product extension strategies
These strategies can attract more customers.
What is one way to decrease direct costs?
Cutting direct material costs by using cheaper suppliers
This can have a negative impact on the quality of goods.
What can cutting direct labor costs lead to?
Resentment and demotivation among staff
Reducing the number of staff can create a negative work environment.
Define profit margin.
A ratio showing the percentage of sales revenue that turns into profit
It is calculated as Profit divided by Revenue times 100.
What does a high profit margin indicate?
Better financial health for the business
A higher profit margin suggests that the company retains more profit from its sales.
What can be negotiated to decrease costs?
Preferential payment terms with trade creditors and suppliers
This can help improve cash flow.
What does Return on Capital Employed (ROCE) measure?
Financial performance of a firm based on capital invested
It assesses how much money is made from the capital invested.
What is the significance of a high ROCE?
Indicates better efficiency in generating revenue from funds
A higher ROCE is generally preferred.
What should ROCE generally exceed?
The interest rate offered at commercial banks
This comparison helps assess the firm’s profitability relative to market rates.
What do liquidity ratios measure?
A firm’s ability to pay its short-term liabilities
Liquidity ratios assess how easily a firm can meet its financial obligations within a year.
What is an acceptable current ratio range?
1.5 - 2.0
A ratio below 1 indicates potential liquidity issues, while above 2 may suggest inefficiencies.
What does a current ratio less than 1 indicate?
The firm is likely in debt
This signals that current liabilities exceed current assets.
What are potential issues with a current ratio greater than 2?
- Too much cash in business
- Too many debtors
- Excess stock
These issues can lead to inefficiency and increased costs.
What is an acceptable acid test ratio?
At least 1:1
A ratio below 1 indicates potential working capital difficulties.
