3.5 Profitability and Liquidity Ratio Analysis

A collection of flashcards covering key concepts related to profitability and liquidity ratios in finance.

What is ratio analysis?

A quantitative management tool for analyzing and judging the financial performance of a business.

What are profitability ratios?

Ratios that examine profit in relation to other figures, such as the ratio of profit to sales revenue.

What does Gross Profit Margin (GPM) show?

The value of gross profit as a percentage of sales revenue.

How is profit margin (PM) calculated?

Net profit as a percentage of sales revenue.

What does Return on Capital Employed (ROCE) measure?

The financial performance of a firm compared to the amount of capital invested.

What is the ideal current ratio benchmark?

1.5 to 2 : 1, meaning for every $1 of current liabilities, a firm should have $1.50 to $2 of current assets.

What is the ideal quick (acid-test) ratio benchmark?

1 : 1, meaning for every $1 of current liabilities, a firm should have $1 of cash or debtors.

What is a strategy to improve gross profit margin?

Increasing the selling price for products with few substitutes.

What limitation might arise when improving profitability ratios?

Every strategy to improve ratios will have drawbacks, such as increased expenses or employee demotivation.

What are liquidity ratios?

Ratios that look at a firm's ability to pay its short-term liabilities.