Ratios

Question 0

Profitability indicators

1) RETURN ON OWNERS INVESTMENT

Answer 0

Profitability indicator that assesses how effectively a business has used the owners capital to earn profit.

Net Profit
—————- x 100
Average Capital

From the owners perspective

Question 1

Profitability definition

Answer 1

Profitability is the ability of the business to earn profit and is measured by comparing profit against a base such as sales, assets and owners equity

Question 2

To find average

Answer 2

Opening + Closing / 2

Question 3

Benchmarks for comparison

Answer 3

• Previous years
• Similar businesses
• Budgeted returns
• Alternative investments

Question 4

Profitability indicators
2) GEARING
Debt ratio

Answer 4

The extent to which the business relies on borrowed funds to finance the purchase of its assets.
DEBT RATIO
Total liabilities
----------------     x 100
Total Assets

Question 5

Profitability indicators
3) RETURN ON ASSETS
(ROA)

Answer 5

-From the managers point of view
-A profitability indicator that assesses how effectively a business has used the assets to generate profit.
Net Profit
————– x100
Average total assets

12% = 12c per $1 of assets

Question 6

Profitability indicators
4) ASSET TURNOVER
(ATO)

Answer 6

An efficiency indicator that measures how productively a business has used its assets to earn revenue.
Sales
—————
Average Total Assets

ATO = 2.7 means that revenue was 2.7 times the size of assets

Question 7

How come a firms ROA decreased despite an increase in ATO

Answer 7

ROA ⬇️ ATO ⬆️

NP ➡️ sales - exp. Sales
—– ——–
Assets Assets

Because there was an increase in expenses

Question 8

EXPENSE CONTROL definition

Answer 8

The firms ability to manage its expenses so that they either decrease,
or in the case of variable expenses (such as cost of sales) increase no faster than sales revenue (control the increase)

Question 9

Profitability indicators

5) GROSS PROFIT MARGIN (GPM)

Answer 9

A profitability indicator that assesses average markup by calculating the percentage of sales revenue that is retained as Gross Profit.

Gross Profit
————— x100
Sales Revenue

Question 10

Profitability indicators

6) NET PROFIT MARGIN (NPM)

Answer 10

Assesses expense control by calculating the percentage of sales revenue that is retained as Net Profit.

Net Profit
————- x100
Sales Revenue

Question 11

LIQUIDITY definition

Answer 11

Refers to the ability of a business to meet its short term debts as they fall due.