Unit 3.5 Profitability and liquidity ratio analysis

Question 1

Types of Ratio Analysis

Answer 1

1. Profitability ratio
2. Liquidity ratio

Question 2

Profitability ratio

Answer 2

asses performance in terms of profit-generating ability

Question 3

Ratio analysis

Answer 3

financial analysis used to interpret and asses a firm’s financial statement

Question 4

Types of profitability ratios

Answer 4

1. Gross profit margin
2. Profit margin

Question 5

strategies to improve gross profit margin

Answer 5

• increase prices / could be damaging to customer loyalty
• source cheaper suppliers/ not compromise quality
• adopt more aggressive promotional strategies
• reduce direct labour costs

Question 6

strategies to improve profit margin

Answer 6

• check unnecessary indirect costs

Question 7

Efficiency ratio

Answer 7

return on capital employed

Question 8

Return on capital employed

Answer 8

asses the returns a firm is making from its capital employed

formula in the booklet

Question 9

Strategies to improve ROCE

Answer 9

• reduce the amount of long-term loans
• pay additional dividends to reduce retained profit

Question 10

Liquidity ratio

Answer 10

Measures the ability of a firm to pay its short-term debt obligations. Need sufficient levels of liquidity to pay day-to-day bills

Question 11

Types of liquidity ratio

Answer 11

1. Current ratio
2. Acid test (quick) ratio

Question 12

Strategies to improve the current ratio

Answer 12

• reduce bank overdrafts and choose long-term bank loans / could increase interest and gearing ratio
• sell existing long-term assets for cash / needed will have to be leased

Question 13

Strategies to improve the acid test (quick) ratio

Answer 13

• sell stock at a discount for cash / reduce original revenue of stock
• increase credit period for debtors to enable more stock sold on credit / if no pay back lead to increased bad debts