Ratio analysis

Question 1

Profitability ratios

Answer 1

Gross profit margin= gross profit/revenue x 100
(shows the percentage of sales revenue is business is able to convert into gross profit)

Net profit margin= net profit before tax x 100/ revenue
(measures how much net income is generated as a percentage of revenue received)

Question 2

Liquidity ratios

Answer 2

Curren ratio= current assets/ current liabilities
(Shows how much assets a business has for every $1 it owes)

The ideal ratio is between 1.5 and 2. Lower means theres not enough money to pay bills and higher means there is too much money tied up in stock.

Acid test ratio= current assets - inventories/ current liabilities
(Shows how many assets that for every $1 a business owes, can be quickly sold to pay for it)
Stock is not included as it is not guaranteed that it will be sold

Question 3

Gearing ratios

Answer 3

Gearing ratio= non-current liabilities/capital employed x 100%
(used to calculate the proportion of long-term funding that comes from debt)

Question 4

Return on capital employed (ROCE)

Answer 4

ROCE= operating profit/ capital employed x 100%
(Compares the profit to its capital)

Capital employed= total equity + non-current liabilities