3.5 Profitability and Liquidity Ratio Analysis

Acid Test Ratio (quick ratio)

Liquidity ratio that measures a firm's ability to meet its short term debts.

• It ignores stock because not all inventories can be turned into cash in a short time frame.

• (current assets - stock) / current liabilites

Capital Employed

the value of all long term sources of finance for a business, namely non-current liabilities plus equity

• non-current liabilities + equity

Current Ratio

short term liquidity ratio that assesses a business's ability to meet its debts within the next twelve months

Current assets / current liabilities

Gross Profit Margin (GPM)

Profitability ratio that shows the value of a firm's gross profit expressed as a percentage of its sales revenue

Gross Profit / Sales Revenue x 100

Liquid Assets

the possessions of a business which can be turned into cash quickly without losing their value (e.g. cash, debtors, stock)

Liquidity Crisis

refers to a situation where a firm is unable to pay its short term debts (i.e. when current liabilities exceed current assets)

Liquidity ratios

looks at the ability of a firm to pay its short term (current) liabilities, comprised of the current ratio, and the acid test (quick) ratio.

Profit Margin

ratio that shows the percentage of sales revenue that turns into profit. (i.e proportion of sales revenue that are left over after all direct and indirect costs have been paid)

(Profit before int. & Tax / Sales Revenue) x 100

Profitability Ratios

Examines profit in relation to other figures, comprised of the Gross Profit Margin (GPM), Profit Margin, and Return on Capital Employed (ROCE) ratios

Ratio Analysis

quantitative management tool that compares different financial figures to examine and judge the financial performance of a business

Return On Capital Employed (ROCE)

profitability ratio that measures the financial performance of a firm based on the amount of capital invested

(profit before int & tax / Capital Employed) x 100