3.5 Profitability and liquidity ratio analysis

Question 1

The acid test ratio (quick ratio)

Answer 1

Is a liquidity ratio that measures a firm’s ability to meet its short-term debts. It ignores stock because not all inventories can be easily turned into cash in a short time frame without losing value.

Question 2

Capital employed

Answer 2

All long-term sources of finance, namely non-current liabilities + equity

Question 3

Current ratio

Answer 3

Is a short-term liquidity ratio that calculates the ability of a business to meet its debts within the next twelve months

Question 4

The Gross profit Margin (GPM)

Answer 4

is a profitability ratio that shows the value of a firm’s gross profit expressed as a percentage of its sales revenue

Question 5

Liquid assets

Answer 5

Are the possessions of a business that can be turned into cash quickly without losing their value, i.e cash, debtors and stock

Question 6

Liquidity crisis

Answer 6

refers to a situation where a firm is unable to pay its short-term debts, i.e current liabilities exceed current assets

Question 7

Liquidity ratios

Answer 7

Look at the ability of a firm to pay its short-term (current) liabilities, comprised of the current ratio and the acid test (quick) ratio

Question 8

Profit margin

Answer 8

Is a ratio that shows the percentage of sales revenue that turns into profit, i.e the proportion of sales revenue left over after all direct and indirect costs have been paid

Question 9

Profitability ratios

Answer 9

Examine profit in relation to other figures, comprised of the gross profit margin (GPM) and return on capital employed (ROCE) ratios

Question 10

Ratio analysis

Answer 10

Is a quantitative management tool that compares different financial figures to examine and judge the financial performance of a business.

Question 11

Return on capital employed (ROCE)

Answer 11

Is a profitability ratio that measures the financial performance of a firm based on the amount of capital invested