Limitations of Ratios

Question 1

What are limitations of ratios?

Answer 1

1. Ratios are averages: Can hide good or poor performance in specific areas of a business.
2. Highlight problems but lack solutions: Don’t explain issues or how to fix them.
3. Snapshot in time: Based on balance sheet data, may not reflect current conditions.
4. Distorted by accounting practices: Reporting methods of figures can mislead or be inaccurate.
5. Hard to compare: Differences in accounting and outdated competitor data may not reflect rivals true situation.
6. Poor performance ≠ failure: Competitive markets or high investments may explain low profits.

Question 2

Gross Profit Margin Formula

Answer 2

Gross Profit Margin = (Gross Profit ÷ Revenue) × 100

Question 3

Mark-up Formula

Answer 3

Mark-up = (Gross Profit ÷ Cost of Sales) × 100

Question 4

Net Profit Margin Formula

Answer 4

Net Profit Margin = (Net Profit ÷ Revenue) × 100

Question 5

ROCE Formula

Answer 5

Return on Capital Employed (ROCE) = (Profit Before Tax ÷ Capital Employed) × 100

Question 6

Current Ratio Formula

Answer 6

Current Ratio = Current Assets ÷ Current Liabilities

Question 7

Liquid Capital Ratio Formula

Answer 7

Liquid Capital Ratio = (Current Assets - Inventory) ÷ Current Liabilities

Question 8

Trade Payable Days Formula

Answer 8

Trade Payable Days = (Trade Payables ÷ Credit Purchases) × 365

Question 9

Trade Receivable Days Formula

Answer 9

Trade Receivable Days = (Trade Receivables ÷ Credit Sales) × 365

Question 10

Inventory Turnover Days Formula

Answer 10

Inventory Turnover Days = (Average Inventory ÷ Cost of Sales) × 365