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Profitability ratios
help show how well a business is doing focusing on profit, capital employed, and total revenue
What is the formula for gross profit?
Sales revenue - COGS (opening balance + purchases - closing balance)
Is a higher gross profit preferable to lower ones?
Yes, a higher gross profit is preferable to lower ones. This is because a higher gross profit means that a company is earning more revenue after deducting the cost of goods sold. It indicates that the company is efficient in managing its production costs and pricing strategy, which can lead to higher profits and better financial stability.
how to improve gross profit margin
Increase prices
Reduce cost of goods sold
Negotiate better supplier contracts
Reduce waste and spoilage
Analyze and adjust pricing strategy
What is a net profit margin?
measures the percentage of profit a company earns from its revenue after deducting all expenses, including taxes and interest. its better when higher
how to improve net profit margin?
Increase revenue
Reduce operating expenses
implement new pricing strategies
what is return on capital employed
profitability and efficiency in relation to its size , compares profit made by business with amount of money invested. better high.
how to improve return on capital employed
Increase revenue
Reduce operating expenses
Improve inventory management
Invest in research and development
Liquidity ratios
determine whether it is in a position where its current assets will be able to to pay any immediate bills that arise.
current ratio
ability for a business to meet short term debts within a year . 1:1 ratio means they have just enough current assets to pay off current liabilities. 2:1 means they are not using their current assets efficiently. 1.5:1 is the best.
how to improve current ratio
Increase current assets
Decrease current liabilities
Acid test ratio
ability to pay short term debts within a year without having to sell stock. important because stock is not guaranteed to be sold. aim to have it at around 1.
how to improve acid test ratio
Increase current assets value
decrease current liabilities value by paying off debts
efficiency ratio analysis
how efficiently a business employs its resources
stock turnover (days)
how quickly a business uses or sells its stock
stock turnover, high, low
higher means the profit earned on stocks is quick which will allow businesses to operate on lower profit margins, lower stock turnover may be because of stockpiling.
how to improve stock turnover
Implement just-in-time (JIT) inventory system
get rid of obsolete stock
Creditor days
how quickly a business pays its debts to suppliers and other short term creditors
should creditor days be high or low
a high creditor days ratio means the business takes longer to pay back its suppliers and short term creditors, although this may be beneficial for the business because it improves their cash flow, they have to be careful not damage relations with suppliers.
how to improve creditor days ratio
Negotiate longer payment terms with suppliers
Increase sales to generate more cash flow
Debtor days
average number of days it takes to collect debts from customers
why should debtor days be low?
the lower, the better because it will mean they collect their debts faster giving them accessibility to use their money
how to improve debtor days?
Impose surcharges on late payments
give debtors incentives to pay earlier such as giving discounts to those who pay before the due date
Gearing ratio
shows relationship between loan capital and share capital to see how much it relies on internal and external sources
what does it mean when gearing ratio is high or low?
when its high it means they are high geared relying mostly on loan capital, when its low it means they rely mostly on share capital. too high or too low is not good, needs to be in between
how to improve gearing ratio
for higher GR: depend on external sources of finance
for low GR: repay creditors
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