3.5 profitability and liquidity ratio analysis

The acid test ratio

a liquidity ratio that measures a firm's ability to meet its short-term debts. It ignores stock because not all inventories can be easily turned into cash in a short time frame.

Capital employed

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

The current ratio

a short-term liquidity ratio that calculates the ability of a business to meet its debts within the next twelve months.

The gross profit margin

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

Liquid assets

the possessions of a business that can be turned into cash quickly without losing their value, i.e. cash, stocks and debtors.

Liquidity crisis

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

Liquidity ratios

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

The profit margin

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

Profitability ratios

examine profit in relation to other figures, comprised of the gross profit margin (GPM), profit margin and return on capital employed (ROCE) ratios.

Ratio analysis

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

The return on capital employed (ROCE)

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