3.5 profitability and liquidity ratios

Question 1

acid test ratio (aka quick ratio)

Answer 1

• 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

Question 2

capital employed

Answer 2

• the value of all long-term sources of finance for a business
• namely non-current liabilities plus equity

Question 3

current ratio

Answer 3

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

Question 4

gross profit margin

Answer 4

• 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

• the possessions of a business that can be turned into cash quickly
• without losing its value

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 ratio

Answer 7

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

Question 8

profit margin

Answer 8

• 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 ratio

Answer 9

• examines profit in relation to other figures
• comprised of the gross profit margin, profit margin and return on capital employed ratios

Question 10

ratio analysis

Answer 10

• a quantitative management tool that compares different financial figures to examine and urge the financial performance of a business

Question 11

return on capital employed

Answer 11

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