Profitabiliy & Performance Ratios

Question 1

What are profitability ratios?

Answer 1

Profitability ratios measure the relationship between gross net profit and sales.

Question 2

What is gross profit margin?

Answer 2

This ratio calculates the amount of gross profit made from each £ of sales revenue.

Question 3

Gross profit margin calculation

Answer 3

(Gross profit / Sales revenue) x100

Question 4

What’s the gross profit margin on supermarket food going to be like compared to perfume?

Answer 4

Perfume gross profit margin is much higher than supermarket food.

Question 5

How can you improve gross profit margin?

Answer 5

• Raising sales revenue whilst keeping the cost of sale the same
• Reducing the cost of sales made whilst maintaining the same level of sales revenue.
• Think about how to add value

Question 6

What is operating profit margin?

Answer 6

Operating profit margin measures the extent to which sales revenue is converted into operating profit.

Question 7

Operating profit margin calculation

Answer 7

(Operating profit / Sales revenue) x100

Question 8

How can we combine GPM and OPM ratios?

Answer 8

The difference between the gross profit margin and the operating profit margin illustrates the extent to which the business is controlling its overheads.

Question 9

How can operating profit margin be improved?

Answer 9

• Raising sales revenue whilst keeping expense low
• Reducing expenses whilst maintaining the same level of sales revenue

Question 10

What is return on capital employed?
(ROCE)?

Answer 10

This is sometimes referred to as the primary efficiency ratio and is perhaps the most important ratio of all.

It measures the efficiency with which the firm generates profit from the funds invested in the business.

Question 11

ROCE (return on capital employed)?

Answer 11

(Operating (Net) Profit / Capital Employed) x100

Question 12

What is capital employed calculation?

Answer 12

Capital employed = non current liabilities + total equity

Question 13

How can ROCE (return on capital employed) be improved?

Answer 13

• Increasing the level of profit generated by the same level of capital employed
• Be busy - high capacity utilisation
• Maintaining the level of profits generated but decreasing the amount of capital it takes to do so.

Question 14

What is a loss?

Answer 14

A loss is a situation where a business’s expenditure exceeds its revenue over a specific trading period.

Question 15

What is meant by high quality profit?

Answer 15

High quality profit is profit that is likely to continue into the future.

Contrast is poor quality profit.

Question 16

How do businesses ‘window dress’ their balance sheets?

Answer 16

• Borrow money for a short period of time to improve their cash position just before the date of the balance sheet.
• Sale and leaseback, sale of major non-current assets
• Maintain the value of intangible assets on the balance sheet at excessive levels.
• Capitalising expenditure
• Bring sales forward to an earlier period to boost revenue.

Question 17

Ratio analysis provides stakeholders with an insight into the performance of a business. However, to offer the max amount of info ratios need to be compared with other data outlined below:

Answer 17

• The results for the same business over previous years.
• The results of ratio analysis for other firms in the same industry
• The results of ratios from firms in other industries.

Question 18

A weakness of ratio analysis is that it only takes financial aspects into account. Other elements should also be taken into account when evaluating performance:

Answer 18

• The market in which the business is trading.
• The position of the firm within the market.
• The quality of the workforce and management team.
• The economic environment.