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L6 Business Management > 3.5 Profitability and liquidity ratio analysis > Flashcards

3.5 Profitability and liquidity ratio analysis Flashcards

1
Q

profitability ratios

A

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

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2
Q

gross profit margin

A

profitability ratio that shows the gross profit as a percentage of sales revenue

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3
Q

gross profit margin formula

A

(gross profit/ sales revenue) * 100

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4
Q

two main ways to improve GPM

A

increase sales revenue
reduce cost of sales

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5
Q

strategies to improve sales revenue

A

diversification (products and markets)
lowering prices
increasing prices

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6
Q

benefits of diversification (products and markets)

A

different products may have higher gross profit margins; may also reduce risk for the business

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7
Q

limitations of diversification (products and markets)

A

costly and risky

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8
Q

benefits of lowering prices

A

can increase sales and sales revenue

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9
Q

limitations of lowering prices

A

only works if the business achieves economies of scale to lower costs of production;
may not be possible for small businesses

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10
Q

benefits of increasing prices

A

can increase sales revenue, especially in products with little competition and/ or loyal customers

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11
Q

limitations of increasing prices

A

in a competitive market, increasing prices may decline sales significantly, lowering sales revenue and GPM

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12
Q

strategies to decrease cost of sales

A

economies of scale
using lower cost suppliers
reducing direct labour costs

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13
Q

benefits of economies of scale

A

purchasing economies of scale would reduce the unit cost and result in higher profit margins

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14
Q

limitations of economies of scale

A

may only be available to lare companies

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15
Q

benefits for using lower cost suppliers

A

reduce cost of sales

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16
Q

limitations of using lower cost suppliers

A

could threaten the quality of products and harm revenues

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17
Q

benefits of reducing direct labour costs

A

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

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18
Q

limitations of reducing direct labour costs

A

pressure on production workers could increase labour turnover, increasing costs of recruiting and training (affecting other profitability ratios)

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19
Q

profit margin (PM)

A

profitability ratio that shows the profit before interest and tax as a percentage of sales revenue

shows how well managers control indirect costs

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20
Q

profit margin formula

A

(profit before interest and tax/ sales revenue) * 100

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21
Q

expenses a business can reduce

A

rent, electricity, stationery, administration costs

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22
Q

how to reduce rent

A

negotiating a lower rental payment for existing premises, or relocating

(however, can be less convenient)

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23
Q

how to reduce electricity

A

monitoring and lowering electricity use, or by using alternatie, lower-cost sources of energy

(however, must ensure it doesn’t result in a lower quality product)

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24
Q

how to reduce stationery

A

lower paper use by relying more on digital communication

(however, may increase energy use)

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25
how to reduce administration costs
reducing administrative staffing or lowering salaries or perks (however, may damage staff motivation)
26
return on capital employed (ROCE)
profitability ratio that shows the profit before interest and tax as a percentage of capital employed
27
formula for ROCE
(profit before interest and tax/ capital employes) * 100
28
capital employed
value of all sources of internal and external finance for a business, calculated from the sum of non-current liabilities and equity
29
capital employed formula
non-current liabilities + equity
30
strategies to improve ROCE
- increase sales revenue to increase profit before interest and tax - reduce cost of sales and expenses to increase profit before interest and tax - sell unused and obsolete assets -reduce long-term liabilities - reduce share capital and retained profit (equity)
31
liquidity ratios
measure a business's ability to settle its short-term debt obligations; comparing the value of current assets to the value of current liabilities
32
insolvency
situation where a business is unable to pay its debts
33
working capital cycle (what is it)
process of turning current assets into cash that can be used to purchase the resources needed to produce a product
34
working capital cycle (order)
cash ---(purchase of supplies)----> creditors ---(production)----> stock/ inventory ----(sales of product)---> debtors
35
cash flow
payments receives by a business (inflows) and payments made by the business (outflows)
36
working capital formula
current assets - current liabilities
37
two types of liquidity ratios
current ratio acid test ratio
38
current ratio
liquidity ratio that measures the vaue of current assets relative to current liabilities, calculated by dividing current assets by current liabilities
39
current ratio formula
current assets/ current liabilities
40
current ratio below 1
company at risk of not being able to cover short-term debts
41
good current ratio
1.5 to 2
42
current ratio too high
inefficient too much money held in cash that could be invested more effictively in the business
43
ways to increase current assets
- increase sales - reduce debtors' figures - sell unused fixed assets - reduce drawings
44
benefits of increasing sales
selling more products with lower prices or increased promotion, or increasing revenue per unit with higher prices, may increase cash coming into the business and reduce stocks
45
limitations of increasing sales
not clear if changing prices or promotion will increase or decrease total revenues. may increase liabilities, so benefits may be cancelled out.
46
benefits of reducing debtors' figures
asking customers who buy on credit to pay sooner with cash can increase cash assets
47
limitations of reducing debtors' figures
demanding cash up front may cause business to lose customers
48
benefirts of selling unused fixed assets
bring in more cash
49
limitations of selling unused fixed assets
careful not to sell assets the business needs to produce its products efficiently
50
benefits of reducing drawings
(drawings= cash withdraws from the business for the owner's personal use) more cash in hand
51
limitations of reducing drawings
owners (usually of small businesses) may need the cash for personal expenses, especially if they don't take a salary
52
methods to reduce current liabilities
- extend credit period - decrease overheads - reduce current liabilities
53
benefits of extending credit period
if business can extend the time it has to pay trade creditors for resources, then trade creditors' figure can be lowered
54
limits of extending credit period
can threaten relationship with suppliers
55
benefits of decreasing overheads
leave company with more working capital to pay off current liabilities
56
limitations of decreasing overheads
may not be able to move to lower cost facilities must also be able careful about motivational issues that might be caused by lowering salaries
57
benefits of reducing current liabilities
using working capital to pay overdrafts and current liabilities will improve the current ratio and save money on interest payments
58
limits of reducing current liabilities
may not have enough working capital to pay down debts more quickly limit funds available to purchase the resources needed to produce its product
59
acid test (quick) ratio
liquidity ratio that measures the value of current assets without stock included, relative to current liabilities measures ability to pay short term debts
60
acid test ratio formula
(current assets - stock)/ current liabilities
61
uses of ratio analysis (groups of people)
employees/ managers suppliers shareholders banks local community
62
limitations of ratio analyses
- incomplete picture of current and future finances - external influences - qualitative factors ignored - different interpretations by social enterprises

L6 Business Management (21 decks)

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