3.5 Profitability and Liquidity Ratio Analysis

Question 1

What is the “gross profit” margin?

Answer 1

Profitability ratio that measures an organization’s gross profit (sales rev - COGS) expressed as a percentage of its sales revenue

Question 2

What is the equation of “gross profit margin (GPM)”?

Answer 2

Gross Profit Margin = ( gross profit/ sales revenue ) x 100

Question 3

What is the “net profit margin (NPM)”?

Answer 3

Profitability ratio that measures a firm’s overall profit (after all costs of productions have been deducted) as a percentage of its sales revenue

Question 4

What is the equation of “net profit margin (NPM)”?

Answer 4

Net profit margin = ( net profit before interest and tax/ sales revenue ) x 100

Question 5

What is the “Return on Capital Employed (ROCE)”?

Answer 5

Measures a firms efficiency and profitability in relation to its size (as measured by the value of the organizations capital employed)

Question 6

What is “capital employed”?

Answer 6

The value of all sources of finance for a business (including both internal and external finance)
–> capital employed = Loan capital + Share capital + Accumulated retained profits

Question 7

What is the equation of “Return on Capital Employed (ROCE)”?

Answer 7

Return on Capital employed (ROCE) = ( NPBIT / Capital employed ) x 100

Question 8

What are “liquidity ratios”?

Answer 8

Financial ratios that examine an organizations ability to pay its short term liabilities and debts

Question 9

What are the 2 “liquidity ratios”?

Answer 9

1. Current ratio

2. Acid test ratio

Question 10

What is the “current ratio”?

Answer 10

The current-ratio is a short term liquidity ratio used to calculate the ability of an organization to meet its short-term debts. It calculates the value of an organizations liquid assets relative to its short-term liabilities.

Question 11

What is the equation of the “current ratio”?

Answer 11

Current ratio = Current assets/ current liabilities

Question 12

What is the “acid test ratio”?

Answer 12

The acid test ratio is also a short term liquidity ratio used to measure the ability of an organization to meet its short-term debts, however it EXCLUDES the stock from the current assets. (As stock isnt always highly liquid)

Question 13

What is the equation of the “acid test ratio”?

Answer 13

Acid test ratio = (Current assets - stocks) / current liabilities