3.5 Profitability and ratio analysis Flashcards
Gross profit margin
gross profit / sales revenue x 100
The higher the GPM
the better
Strategies can be used to raise revenue
finding cheaper suppliers
economies of scale
Lowering the cost of goods sold
cheaper suppliers
reduce direct labour costs either by hiring fewer workers or by using non-financial motivation strategies
Net profit margin
net profit before interest and tax / sales revenue x 100
Strategies to improve NPM
increase sales revenue
lower cost of goods sold
reduce operating expenses
ROCE
how efficiently a company can generate profits from its capital employed
ROCE formula
net profit before interest and tax / capital employed x 100
Capital employed
long term liabilities + share capital + retained profits
fixed assets + current assets - current liabilities
Strategies to improve the ROCE
reduce long term liabilities - paying off debt or restructuring loans by renegotiating a longer repayment period
Liquidity
firm’s ability to convert its short-term assets into cash
Two types of liquidity ratios
current ratio
acid test ratio
Current ratio
current asset / current liabilities
Recommended current ratio
1.5 to 2
Strategies to improve current ratio
reduce current liabilities: paying short term loans
sale of unused fixed assets
