Evaluating Business Performance - Profitability Flashcards
Debt Ratio
a stability indicator that measures the percentage of a firm’s assets that are financed by liabilities (external sources of finance)
Return on Owner’s Investment
A profitability indicator that indicates how efficiently a business has used the owner’s capital to earn profit.
Return on Assets
A profitability indicator that indicates how effectively a business has used its assets to earn / generate profit.
Assessment of profitability from the manager’s perspective.
Profitability
the ability of the business to earn a profit, measured by comparing its profit against a base, such as sales, assets or owner’s equity.
Liquidity
the ability of the business to meet its short term debts as they fall due.
Stability
the ability of the business to meet its debts and continue operations in the long term.
Profit
under accrual basis accounting, revenues earned minus expenses incurred within a Period, expressed in dollar terms.
Asset Turnover
An efficiency indicator which measures how productively a business has used its assets in the generation of sales revenue.
- It measures the number of times in the period the value of assets is earned as sales revenue: the faster the ATO, the more capable the firm is of using its assets to earn revenue.
Gross Profit Margin
A profitability indicator that measures the average mark-up by calculating the percentage of sales revenue that is retained as gross profit.
Net Profit Margin
A profitability indicator that measures expense control by calculating the percentage of sales revenue that is retained as net profit.
Strategies to increase gross profit margin
- Increase selling price, but must maintain same sales volume at a minimum
- Reduce cost price of Inventory:
- Negotiate better deal with existing supplier
- Buy in bulk to take advantage of lower pricing
- Seek a new supplier
- Decrease quality of Inventory however this can lead to problems with increased sales returns and complaints
Should always consider the ethical impact of any decisions made.
Strategies to increase revenue
Can be used to improve ROA, ATO and NPM
Note: If using for ROA and NPM, Revenue needs to grow faster than expenses
Strategies to reduce average total assets
Can improve Asset Turnover and Return on Assets
- If can’t increase sales, reduce assets → particular unproductive / idle / obsolete assets.
- Sell assets, and then lease back
Strategies to control expenses
Can be used to improve NPM and ROA
Strategies to improve generation of revenue
Strategies to improve expense control
Non-financial indicators
Non-financial indicators relate to any information that cannot be found in the financial statements, and is not expressed in dollars and cents, or reliant on dollars and cents for its calculation.
The firm’s relationship with its customers (non-financial indicators):
- Customer satisfaction
- Number of repeat sales
- Number of sales returns
- Number of customer complaints
- Number of sales enquiries / catalogue requests
- Degree of brand recognition, based on market research
The suitability of inventory (non-financial indicators)
- Number of sales returns
- Number of purchase returns
- Number of customer complaints
The firm’s relationship with its employees (non-financial indicators)
- Performance appraisals
- Days lost due to sick leave or industrial action
- Staff turnover
- Average length of employment
Implications of a high debt ratio
Positive:
- Funds can be used to expand / grow the business
- Funds used to replace old and inefficient assets
Negative:
- Increases risk in the business as external sources of finance must be paid back in line with contractual arrangements negatively impacting on stability.
- Cash required to service debt, taking it away from other areas of the business.
- Makes sourcing additional funds more difficult as financial institutions will not lend if the debt ratio is high.
