3.5 profitability and liquidity ratio analysis

Question 1

profitability ratios

Answer 1

financial ratios that show the profit of a business in relation to other financial figures

Question 2

why are businesses interested in profitability ratios?

Answer 2

because they help the business understand how well it is using the spending on resources to generate profit
also help investors decide wether to invest or not

Question 3

what does high profitability mean for shareholders

Answer 3

higher dividends for shareholders

Question 4

gross profit margin

Answer 4

shows the gross profit as a percentage of sales revenue

Question 5

strategies to improve sales revenue

Answer 5

diversification
lowering prices
increasing prices

Question 6

gross profit margin formula

Answer 6

gross profit revenue/sales revenue x 100

Question 7

diversification

Answer 7

benefits: different products may have higher gross profit margins. this can also reduce risk for the business
limitations: can be costly and risky

Question 8

lowering prices

Answer 8

benefits: can increase sales and sales revenue
limitations: only works if the business achieves economies of scale to lower costs of production may not be possible for small business

Question 9

increasing prices

Answer 9

benefits: can increase sales revenue, especially where the product has little competition and/or loyal customers
limitations: in a competitive market, increasing prices may cause sales to decline significantly, lowering sales revenue and GPM

Question 10

benefits and limitations of strategies to decrease cost of sales

Answer 10

economies of scale
using lower cost suppliers
reducing direct labour costs

Question 11

economies of scale

Answer 11

benefit: purchasing economies of scale would reduce the unit costs and result in higher profit margins
limitations: economies of scale may only be available to large companies. May not be possible for small businesses

Question 12

using lower cost suppliers

Answer 12

benefits: lower cost suppliers would reduce cost of sales
limitations: could threaten the quality of products and harm revnues

Question 13

reducing direct labour costs

Answer 13

benefits : Productivity can be improved and costs can be reduced either by hiring fewer workers who are directly involved in production, or by using non-financial motivation strategies
limitations: pressure on production workers could increase labour turnover, increasing costs of recruiting and training (and affecting other profitability ratios)