Financial Ratios and Performance Drivers

Vocabulary flashcards covering key financial ratios, their formulas, and principal factors that improve or deteriorate each measure.

Gross Profit Margin – Ways to Improve

Shift in sales mix towards higher-margin products

Why: Higher mark-up products retain more profit per sale, boosting the margin even without more sales

Gross Profit Margin – Ways to Deteriorate

Increased input costs not passed to customers

Why: Rising supplier prices or currency depreciation squeeze margins if selling prices stay fixed.Reduction in sales volume of higher-margin products

Operating Profit Margin – Ways to Improve

Better cost control on overheads (admin, selling, distribution)

Why: Streamlined operations reduce expenses, leaving more profit from each dollar of sales.

Operating Profit Margin – Ways to Deteriorate

Increase in administrative or distribution expenses

Why: Higher staff costs, marketing campaigns, or fuel costs erode operating profits.due to rising operational costs and inefficiencies.

Net Profit Margin – Ways to Improve

Non-operating income gains (e.g., profit on asset disposals)

Why: Additional income streams increase overall profitability beyond operations.

Net Profit Margin – Ways to Deteriorate

Higher finance costs due to rising interest rates or more borrowings

Why: Greater interest expense reduces profit available at the bottom line.

ROCE – Ways to Improve

Increased efficiency in asset utilisation

Why of why: Same capital base generating higher operating profit boosts return.

ROCE – Ways to Deteriorate

Declining profitability from competitive pressure

Why: Lower margins mean less profit generated per dollar of capital invested.

Inventory Turnover – Ways to Improve

Better inventory management with reduced holding times

Why: Efficient purchasing and production planning mean stock is sold faster, improving turnover

Inventory Turnover – Ways to Deteriorate

Over-purchasing or overproduction

Why: Holding excess stock inflates inventory levels without immediate matching sales.

Inventory Days – Ways to Lower (Improve)

Impoved demand forecasting

Why of why: Accurate forecasts prevent overstocking, reducing average inventory days.

Inventory Days – Ways to Rise (Deteriorate)

Slow-moving or obsolete inventory

Why of why: Unsellable or low-demand stock increases the average holding time.

Payables Period – Ways to Improve (Lengthen)

Negotiating longer credit terms with suppliers

Why of why: Extending payment deadlines frees up working capital for other uses.

Payables Period – Ways to Deteriorate (Shorten)

Taking advantage of early payment discounts unnecessarily

why: Paying early without needing to may reduce available working capital.

Asset Turnover – Ways to Improve

Better utilisation of fixed assets to generate revenue

Why:More production or sales from the same asset base increases turnover

Asset Turnover – Ways to Deteriorate

Investment in new assets without immediate revenue growth

Why of why: Larger asset base with same revenue decreases turnover ratio.

Current Ratio – Ways to Improve

Better working capital management (e.g., reducing short-term debt)

why: Lower current liabilities relative to assets improves liquidity position

Current Ratio – Ways to Deteriorate

Increase in short-term borrowings or payables without increasing current assets

Why of why: Larger immediate obligations reduce liquidity cushion.

Quick Ratio – Ways to Improve

Reduction in current liabilities through early settlement of debt

Why of why: Smaller short-term obligations raise the quick ratio.

Quick Ratio – Ways to Deteriorate

Increase in short-term borrowings

Why of why: More liabilities reduce liquidity unless matched by cash inflows.

Gearing Ratio – Ways to Improve (Lower)

Repayment of borrowings without replacing with new debt

Why of why: Reduces reliance on external financing, lowering leverage risk.

Gearing Ratio – Ways to Deteriorate (Higher)

New borrowings to finance expansion

Why of why: More debt increases fixed interest obligations and financial leverage

Interest Cover – Ways to Improve

Reduction in finance costs from refinancing or debt repayment

Why of why: Lower interest expense increases coverage ratio.

Interest Cover – Ways to Deteriorate

Increase in finance costs due to higher interest rates or borrowings

Why of why: Higher obligations reduce the margin of safety for covering interest.

EPS – Ways to Improve

Increase in profit after tax without increasing shares

Why of why: Higher earnings spread across the same number of shares means more profit per share.

EPS – Ways to Deteriorate

Issue of new shares without proportional profit increase

Why of why: More shares dilute earnings unless profits grow in step.

Receivable collection period - way to improve

Offering early payment discounts

why: Incentives encourage customers to pay sooner, reducing average receivable days

Receivable collection period - way to deteriorate

Increased sales to higher-risk customers

Why of why: Customers with weaker liquidity tend to pay late, lengthening collection time.