Chapter 31: Ratio Analysis (Version) Flashcards
What is ratio analysis?
Mathematical approach to investigating accounts by comparing two related figures.
What are profitability ratios?
Ratios that measure a business’s performance in terms of profit, revenue, and investment.
What are liquidity ratios?
Ratios that measure how easily a business can pay its short-term debts, such as wages or suppliers.
What is the formula for Gross Profit Margin?
Gross Profit Margin = (Gross Profit / Revenue) × 100
What is Gross Profit Margin?
Gross profit expressed as a percentage of turnover. A higher margin is better.
What is the formula for Operating Profit Margin?
Operating Profit Margin = (Operating Profit / Revenue) × 100
Operating profit margin
Operating profit expressed as a percentage of turnover.
Why is Operating Profit Margin important?
It indicates how well a business controls its operating expenses and cost of sales.
What is Mark-up and its formula?
Mark-up = (Profit per item / Cost per item) × 100. It helps businesses set prices to cover costs and ensure profit.
What is liquidity?
How easily & quickly an asset can be converted into cash.
Which are more liquid: current or non-current assets?
Current assets are more liquid than non-current assets.
What is the least liquid current asset?
Inventories, as their sale is not guaranteed.
What is the formula for the Current Ratio?
Current Ratio = Current Assets / Current Liabilities
Current ratio
Assesses the firm’s liquidity & ability to pay short-term debts
What does the Current Ratio indicate?
/
What is the Acid Test Ratio?
A stricter liquidity measure that excludes inventory from current assets.
What is the formula for the Acid Test Ratio?
Acid Test Ratio = (Current Assets - Inventory) / Current Liabilities
What does an Acid Test Ratio below 1 indicate?
Current assets (excluding inventory) do not cover current liabilities, which could be a liquidity risk.
What is Return on Capital Employed (ROCE)?
Profit of a business as a percentage of the total amount of money used to generate it.
What is the formula for ROCE?
ROCE = (Operating Profit / Capital Employed) × 100
Why is ROCE useful?
It links profit to the size of the business and compares returns with alternative investments.
How can ratios help businesses?
They assess financial health, monitor progress over time, and compare performance with competitors.
Why should care be taken when comparing ratios between businesses?
Differences in product lines, investments, and market conditions can affect financial ratios.
