3.5 Profitability and ration analysis Flashcards
acid test ratio (Quick ratio)
The acid test ratio 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.
Acid test ratio =
(Current assets - Stock) / Current Liabilities
Capital employed
Capitalemployed is the value of all long-term sources of finance for a business, e.g. bank loans, share capital and reserves.
Current ratio
The current ratio is a short-term liquidity ratio that calculates the ability of a business to meet its debts within the next twelve months.
Current ratio
= Current assets / Current liabilities
Efficiency ratios
Efficiency ratios indicate how well a firm’s resources have been used, such as the amount of profit generated from the available capital used in the business.
Gross profit margin (GPM)
Gross profit margin (GPM) is a profitability ratio that shows the percentage of sales revenue that turns into gross profit.
GPM = (Gross profit/Sales revenue) x 100
Liquid assets
Liquid assets are the possessions of a business that can be turned into cash quickly without losing their value, i.e. cash, stock and debtors.
Liquidity crisis
Liquidity crisis refers to a situation where a firm is unable to pay its short-term debts, i.e. current liabilities exceed current assets.
Liquidity ratios
Liquidity ratios look at the ability of a firm to pay its short-term liabilities, such as by comparing working capital to short-term debts.
Net profit margin (NPM)
Net profitmargin (NPM) shows the percentage of sales revenue that turns into net profit,i.e. the proportion of salesrevenue left over after all direct and indirect costs have been paid.
NPM = (Net profit/Sales revenue) x 100
Profitability ratios
Profitability ratios examine profit in relation to other figures, e.g. the GPM and NPM ratios. These ratios tend to be relevant to profit-seeking businesses rather than for not-for-profit organizations.
Ratio analysis
Ratio analysis is a quantitative management tool that compares different financial figures to examine and judge the financial performance of a business. It requires the application of figures found in the final accounts (the balance sheet and the profit and loss account).
Return on capital employed (ROCE)
Return on capital employed (ROCE) is an efficiency ratio (although it also reveals the firm’s profitability) measuring the profit of a business in relation to its size (as measured by capital employed).
ROCE = (Net profit before interest and tax / Capital employed ) x 100
