3.5

Ratio Analysis

A quantitative financial analysis tool for judging the financial performance of a business based on financial statements.

Profitability Ratios

Ratios that examine an organisation's profit-making ability, including gross profit margin, profit margin, and return on capital employed (ROCE).

Gross Profit Margin

Shows the percentage of gross profit in relation to revenue, calculated as gross profit ÷ revenue × 100.

Profit Margin

Shows the percentage of net profit before interest and tax in relation to revenue, calculated as profit before interest & tax ÷ revenue × 100.

Return on Capital Employed (ROCE)

A profitability ratio that measures how well capital employed is used to generate profit, calculated as profit before interest & tax ÷ capital employed × 100.

Liquidity Ratios

Ratios that examine an organisation's ability to pay for its current liabilities, such as the current ratio and the acid test ratio.

Current Ratio

A liquidity ratio that compares an organization’s current assets to current liabilities, calculated as current assets ÷ current liabilities.

Acid Test (Quick) Ratio

A strict liquidity ratio that compares current assets less stock to current liabilities, calculated as (current assets – stock) ÷ current liabilities.

Liquid Assets

Possessions of a business that can be quickly converted into cash without losing value, such as cash, stocks, and debtors.

Liquidity Crisis

A situation where a firm is unable to pay its short-term debts, meaning current liabilities exceed current assets.

Profitability Ratios

Ratios that assess a firm's profit in relation to other figures, including gross profit margin, profit margin, and ROCE.

Strategies to improve Gross Profit Margin

Adjust pricing, increase promotion, reduce cost of sales through cheaper suppliers or labor.

Strategies to improve Profit Margin

Improve working capital, negotiate early payment discounts, reduce expenses and cut overhead costs.

Strategies to improve ROCE

Reduce non-current liabilities, increase dividends to reduce retained profits.

Strategies to improve Liquidity Ratio

Increase current assets by selling non-current assets, decrease current liabilities by shifting to long-term financing.

Liquidity

The state of being able to meet current liabilities; considers cash and other liquid assets.