Unit 3.5 - Profitability and liquidity ratio analysis

Question 1

Return on capital employed (ROCE)

Answer 1

• An efficiency ratio (although it also reveals the firm’s profitability) measuring the profit of a business in relation to its size (as measured by capital employed)
• ROCE is often referred to as the key ratio

Question 2

The acid test ratio

Answer 2

• Liquidity ratio that measures a firm’s ability to meet its short-term debts
• It ignores stock because not all inventories can be easily turned into cash in a short time frame.

Question 3

Capital employed

Answer 3

The value of all long-term sources of finance for a business

e.g. bank loans, share capital and accumulated retained profit

Question 4

Current ratio

Answer 4

Short-term liquidity ratio that calculates the ability of a business to meet its debts within the next twelve months

Question 5

Efficiency ratios

Answer 5

Indicate how well a firm’s resources have been used, such as the amount of profit generated from the available
capital used in the business

Question 6

Gross profit margin (GPM)

Answer 6

A profitability ratio that shows the percentage of sales revenue that turns into gross profit

Question 7

Liquid assets

Answer 7

The possessions of a business that can be turned into cash quickly without losing their value
(i.e. cash, stock and debtors)

Question 8

Liquidity crisis

Answer 8

A situation where a firm is unable to pay its short-term debts
(i.e. current liabilities exceed current assets)

Question 9

Liquidity ratios

Answer 9

Look at the ability of a firm to pay its short-term liabilities, such as by comparing working capital to short-term debts

Question 10

Net profit margin (NPM)

Answer 10

Shows the percentage of sales revenue that turns into net profit
(i.e. the proportion of sales revenue left over after all direct and indirect costs have been paid)

Question 11

Profitability ratios

Answer 11

• Examine profit in relation to other figures
  (e. g. the GPM and PM ratios)
• These ratios tend to be relevant to profit-seeking businesses rather than for not-for-profit organizations

Question 12

Ratio analysis

Answer 12

• A quantitative management tool that compares different financial figures to examine and judge the financial performance of a business
• It requires the application of figures found in the final accounts (the balance sheet and the profit and loss account)