Chapter 16 : Financial statements analysis

Question 1

Define the term profitability

Answer 1

Profitability is the ability of a business to generate excess income to cover its expenses

Question 2

Explain why it is important for a business to be profitable

Answer 2

It is important for a business to be profitable so that the business is able to :
- continue operating and to sustain in the long term
- distribute profits to the owners for their contributions to the business
- reward employees and retain them to continue to work for the business
- attract other investors
- measure the demand for the products or services offered by the business, in terms of its ability to sell and thus possibility of future expansion

Question 3

state ways to improve profitability of a business

Answer 3

• sell goods at a higher price
• buy goods at lower cost price by buying in bulk to obtain trade discount or switching to another supplier that offers lower prices, without compromising on quality
• reduce operating expenses by relocating to another premise that charges lower rental, capitalizing on technology to reduce cost of manpower and hiring freelancers or part-timers on a need’s basis
• increase sources of other income by subletting excess space to another business to earn rental income or pay early to take advantage of cash discounts.

Question 4

Define the term gross profit margin

Answer 4

gross profit margin measures how much gross profit a business earns for every dollar of net sales revenue

Question 5

Define the term mark-up on cost

Answer 5

Mark-up on cost measures how much gross profit a business earns for every dollar of its cost of sales

Question 6

Define the term profit margin

Answer 6

Profit margin measures how much profit a business earns for every dollar of net sales revenue

Question 7

Define the term return on equity

Answer 7

Return on equity measures how much profit a business earns for every dollar of equity invested by the owner or shareholders in the business

Question 8

Define the term liquidity

Answer 8

Liquidity is the ability of a business to repay its current liabilities when they fall due. It measures the ability of a business to convert current assets into cash to pay for current liabilities.