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unit 3/4 accounting > Measuring the financial performance of a business > Flashcards

Measuring the financial performance of a business Flashcards

1
Q

What is profitability?

A

The ability to earn profit compared to a base figure such as sales, average assets or owner’s investment

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2
Q

What are the profitability indicators?

A
  • Gross profit margin
  • Net profit margin
  • Return on assets
  • Asset turnover
  • Return on owner’s investment
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3
Q

Gross profit margin (GPM)

A

= (Gross profit / Net sales) x 100

  • Measures the avg mark-up of inventory by calculating the percentage of sales revenue retained as gross profit after cost of goods sold has been deducted
  • Expressed as percentage
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4
Q

How can GPM be improved?

A
  • Increase avg selling price of stock
  • Decrease avg cost prices (bulk buying, cheaper suppliers)
  • Decrease sales returns
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5
Q

Net profit margin (NPM)

A

= (Net profit / Net sales) x 100

  • Measures expense control by calculating % of sales retained as net profit
  • Expressed as percentage
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6
Q

How can NPM be improved?

A
  • Increase avg selling price of stock
  • Decrease avg cost prices
  • Decrease sales returns
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7
Q

Return on assets (ROA)

A

= (Net profit / Avg total assets) x 100

  • Measures how effectively business has used assets to earn profit
  • Expressed as percentage
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8
Q

How can ROA be improved?

A
  • Reduce value of avg assets (use assets efficiently, sell idle/unproductive assets)
  • Improve net profit through expense control
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9
Q

Asset turnover (ATO)

A

= Net sales / Avg total assets

  • Measures the number of times in a period the value of assets is earned as sales revenue
  • Expressed as times per period
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10
Q

How can ATO be improved?

A
  • Increase net sales
  • Decrease avg total assets
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11
Q

Return on owner’s investment (ROI)

A

= (Net profit / Avg OE) x 100

  • Measures how effectively business has used owner’s capital to earn profit
  • Expressed as percentage
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12
Q

How can ROI be improved?

A
  • Improve net profit through expense control/sales growth
  • Reduce avg OE by using liabilities to fund assets
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13
Q

What is liquidity?

A

The ability to meet short term debts as they fall due

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14
Q

What are the liquidity indicators?

A
  • Cash flow cover
  • Working capital ratio
  • Quick asset ratio
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15
Q

Cash flow cover (CFC)

A

= Net flows from operating activities / Avg current liabilities

  • Measures the number of times net cash flows from operating activities is able to cover avg current liabilities
  • Expressed as times per period
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16
Q

How can CFC be improved?

A
  • Increase net cash flows from operating activities
  • Decrease avg current liabilities
17
Q

Working capital ratio (WCR)

A

= Current assets / Current liabilities

  • Measures the ratio of current assets to current liabilities
  • Assesses firm’s ability to meet short term debts
  • Expressed as a ratio current assets:1
18
Q

How can WCR be improved?

A
  • Increase CA
  • Decrease CL
19
Q

Quick asset ratio (QAR)

A

= (CA - inventory - prepaid expenses) / (Current liabilities)

  • Measures the ratio of quick assets to current liabilities to assess the business’ ability to meet its immediate debts
  • Expressed as ratio quick assets:1
20
Q

How can QAR be improved?

A
  • Increase CA
  • Decrease CL
21
Q

What is efficiency?

A

Using assets as well as possible to generate sales, cash flow, and profit.

22
Q

What are the efficiency indicators?

A
  • Inventory turnover
  • Accounts payable turnover
  • Accounts receivable turnover
23
Q

Inventory turnover (ITO)

A

= (Avg inventory / Cost of good sold) x 365

  • Measures avg number of days it takes the business to convert inventory into sales
  • Expressed in number of days
24
Q

How can ITO be improved?

A
  • Decrease avg inventory
  • Increase COGS
25
Q

Accounts payable turnover (APTO)

A

= (Avg accounts payable / Net credit purchases plus GST) x 365

  • Measures avg number of days it takes business to pay its accounts payable
  • Expressed in number of days
26
Q

How can APTO be improved?

A
  • Increase avg accounts payable
  • Decrease net credit purchases
27
Q

Accounts receivable turnover (ARTO)

A

= (Avg accounts receivable / Net credit sales plus GST) x 365

  • Measures avg number of days it takes the business to receive cash from its AR
  • Expressed in number of days
28
Q

How can ARTO be improved?

A
  • Decrease avg accounts receivable
  • Increase net credit sales
29
Q

What is stability?

A

The ability of the business to meet its debts and operate into the long-term

30
Q

What is the stability indicator?

A

Debt ratio

31
Q

Debt ratio

A

= (total liabilities / total assets) x 100

  • Measures the level of assets funded by borrowed funds
  • Expressed as a percentage
32
Q

How can debt ratio be improved?

A
  • Decrease total liabilities
  • Increase total assets
33
Q

What are non-financial indicators?

A

Tools other than financial, that help to assess business performance

34
Q

Examples of non-financial indicators

A
  • Number of sales returns
  • Number of repeat customers
  • Number of customer complaints
  • Number of website hits
  • Staff/customer satisfaction surveys
  • Economic climate

unit 3/4 accounting (12 decks)

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