Unit 4

Question 1

gross profit margin

Answer 1

gross profit/sales *100 = %

Question 2

net profit margin

Answer 2

net profit/sales *100 = %

Question 3

ROI/ROCE

Answer 3

return on investment/ return on capital employed

net profit/capital employed *100 = %

Question 4

capital employed

Answer 4

ordinary share capital + retained earnings + long term loans + preference shares

Question 5

preference shares

Answer 5

these shares entitle the holder to a fixed dividend that will be paid in priority over dividend payments to ordinary shareholders

Question 6

what does gross profit margin show

Answer 6

percentage profit on all items sold. profit % on trading. the higher the % the better

Question 7

what does net profit margin show

Answer 7

overall % profit after covering all costs, including expenses. higher the better

Question 8

what does ROI show

Answer 8

measures the level of profit the business can generate from the money invested by shareholders and banks

Question 9

current ratio/ working capital ratio

Answer 9

current assets : current liabilities
ideal 2 :1

Question 10

acid test ratio/quick ratio

Answer 10

current assets - closing stock : current liabilities
ideal 1 : 1

Question 11

what do liquidity ratios tell us

Answer 11

shows the ability of a business to pay its current liabilities as they fall due
ideal ratio 2 : 1

Question 12

how to overcome liquidity problem

Answer 12

1. credit control (limit credit + encourage repayments)
2. stock control (keep to minimum)
3. raise finance e.g. equity finance
4. financial planning to identify shortfalls

Question 13

liquidity

Answer 13

the ability of a business to pay its short term liabilities as they fall due

Question 14

solvency

Answer 14

the ability of a business to pay all its debts as they fall due

Question 15

debt/equity ratio

Answer 15

debt capital : equity capital

Question 16

debt capital

Answer 16

bank loans + debentures + preference shares

Question 17

equity capital

Answer 17

ordinary share capital + retained earnings

Question 18

what does the gearing ratio tell us

Answer 18

shows level of debt/equity capital invested in business. high gearing can indicate risk of business collapse

Question 19

low gearing

Answer 19

debt capital < equity capital

Question 20

high gearing

Answer 20

debt capital > equity capital

Question 21

problems facing highly geared business

Answer 21

1. less money to pay dividends -> shareholders may sell and lower market share
2. difficulty obtaining further debt finance (high risk)
3. difficulty raising equity finance (viewed as high risk by shareholders)
4. management stress to increase profits (meet interest payments + provide adequate dividend)