Ratios c2 Flashcards
What does gross profit margin measure?
It compares the gross profit achieved by a business with the revenue it generated
What is the calculation for gross profit margin?
Gross profit/sales revenue x100 = GPM%
What is the ideal for GPM?
The higher the better, but overheads still have to be paid.
How can the GPM be improved?
reducing cost of sales (e.g. cheaper supplier), increase sales/ revenue (e.g. lower price to up demand whilst keeping costs the same)
What does the return on capital employed measure?
Compares the net profit achieved with the capital invested to achieve it. It measures how good the firm is at generating profit from funds invested.
What is the calculation for ROCE?
Net profit/capital employed(SF+LTL) = ROCE%
What is the ideal for ROCE?
The higher the better
Additional info on ROCE?
The most important ratio, it measures profitability, can be used to compare competition.
What does the Acid test ratio measure?
compares current assets and current liabilities but it deducts stock from current assets. This is because stock is the most illiquid CA.
What is the calculation for Acid test ratio?
(Current assets - stock)/Current liabilities :1
What is the ideal ratio for the acid test?
1:1
what do low results for acid test mean?
they may have difficulty meeting short term debts, however, some businesses can operate on low results if money is tied up in stock e.g. redrow.
How can the ATR be improved?
By reducing the levels of stock whilst maintaining overall current asset total.
What does the net profit margin compare?
Compares net profit achieved with revenue generated.
What is the calculation for net profit margin?
net profit/sales revenue x100
what is the ideal for NPM?
The higher the better
Which is a better indication or performance, GPM or NPM?
NPM as it shows how costs have been managed.
How can the NPM be improved?
increase gross profit whilst keeping expenses the same OR maintain gross profit levels and reduce overheads
What does the current ratio measure?
Looks at the Current assets and current liabilities, it examines the liquidity position of the firm.
What is the calculation for Current ratio?
current assets/current liabilities :1
What is the ideal for Current ratio?
approximately 1.5:1
What if the current ratio is too high?
Too many resources tied up in unproductive assets.
What if the current ratio is too low?
Might not be able to pay debts as they fall due.
How to increase the current ratio if it’s too low?
sell under used assets(raise cash), increase long term borrowing(gearing), raise more share capital.
How to lower the current ratio if it’s too high?
invest cash in the business(improve efficiency/buy assets), too much cash left for the business supposed to be risk takers.
What does gearing measure?
It measures the long term loans as a proportion of a firm’s capital employed. It shows how reliant a firm is upon borrowed money.
What is the equation for gearing?
long term liabilities/Shareholder funds+long term liabilities x 100
What percentage is considered highly geared?
Above 50%
Why are highly geared companies susceptible to financial difficulties?
Because they have to keep paying high interest payments even if sales fall
What if the gearing % is too high?
If interest rates increase, this will increase cash outflow making it difficult to attract new investors.
What if the gearing % is too low?
It can be positive as you’re not reliant upon borrowed money, however, could be considered too safe and not a risk taker.
