3.5 Profitability and Liquidity Ratio Analysis

Flashcards based on the lecture notes covering profitability and liquidity ratio analysis.

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) measure?

GPM shows the value of gross profit as a percentage of sales revenue.

How is Profit Margin (PM) defined?

PM shows the value of net profit as a percentage of sales revenue.

What does the Return on Capital Employed (ROCE) indicate?

ROCE is a profitability ratio that measures the financial performance of a firm compared to the amount of capital invested.

What is the ideal benchmark for the current ratio?

The ideal benchmark for the current ratio is between 1.5 and 2 : 1.

What does the quick ratio measure?

The quick ratio measures short-term liquidity by ignoring stocks.

What is a key strategy to improve Gross Profit Margin?

Raise revenue through various methods such as increasing prices for products with few substitutes.

What is one limitation of strategies used to improve profitability ratios?

Every strategy will have drawbacks, such as increasing expenses, which can negatively impact profitability.

What are liquidity ratios?

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

What is working capital?

The capital of a business used in day-to-day trading operations, calculated as current assets minus current liabilities.

What should a business do if its liquidity ratio exceeds benchmarks?

While it may appear favorable, exceeding liquidity benchmarks can indicate inefficiency in asset utilization.

What are potential drawbacks of increasing current assets?

Investing in stock control systems requires cash, which can reduce liquidity.

What does the BCG Matrix analyze?

The BCG matrix analyzes the product portfolio of a firm and its impact on financial ratios.