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IBBusinessDPBusiness ManagementSLFlashcards3. Finance & Accounts3.5 Profitability & Liquidity Ratio Analysis

3.5 Profitability & Liquidity Ratio Analysis (DP IB Business Management)

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  • Define the term gross profit margin.

    Gross profit margin is the proportion of revenue that is turned into gross profit, expressed as a percentage.

  • What is the formula to calculate the gross profit margin?

    Formula.

    Gross space profit space margin space equals space fraction numerator Gross space profit over denominator Sales space revenue end fraction space cross times space 100

  • Define the term profit margin.

    The profit margin is the proportion of revenue that is turned into profit before interest and tax, expressed as a percentage.

  • What is the formula to calculate the profit margin?

    Formula.

    Profit space margin space equals space fraction numerator Profit space before space interest space & space tax over denominator Sales space revenue end fraction space cross times space 100

  • What is the return on capital employed?

    The return on capital employed is a measure of how effectively a business uses capital invested to generate profit, expressed as a percentage.

  • What is the formula to calculate return on capital employed?

    Formula.

    Return space on space capital space employed space equals space fraction numerator Profit space before space interest space & space tax over denominator Capital space employed end fraction space cross times space 100

  • True or False?

    A higher return on capital employed is generally better.

    True.

    A higher return on capital employed is generally better, as it indicates that the business is profitable and using its capital efficiently.

  • How is capital employed calculated?

    Formula.

    Capital space employed space equals space space Non minus current space liabilities space plus space Equity

  • True or False?

    Return on capital employed can be compared over time and also with competitors and other potential capital investments.

    True.

    Return on capital employed can be compared over time and also with competitors and other potential capital investments.

  • State one way the gross profit margin can be increased.

    The gross profit margin can be increased by:

    • Increasing the value of sales to increase sales revenue

    • Increasing the volume of sales to increase sales revenue

    • Reducing direct costs

  • State two ways a business may reduce its overhead costs.

    Overhead costs may be reduced by:

    • Reducing staffing levels

    • Relocating to cheaper premises

    • Changing utility companies

    • Reducing administration costs

  • True or False?

    Buying stock in greater quantities will reduce direct costs.

    False.

    Buying stock in greater quantities may lead to bulk buying discounts but may require investment in increased storage space

  • What is meant by the term liquidity?

    Liquidity is the cash and other current assets businesses have available to quickly pay bills and meet short-term financial obligations.

  • What is the formula to calculate the current ratio?

    Formula.

    Current space ratio space equals space fraction numerator Current space assets over denominator Current space liabilities end fraction space equals space ? space colon space 1

  • How does the acid test ratio differ from the current ratio?

    The acid test ratio is a more precise way to measure liquidity than the current ratio, excluding stock from current assets.

  • What is the formula to calculate the acid test ratio?

    Formula.

    Acid space test space ratio space equals space space fraction numerator Current space assets space minus space stock over denominator Current space liabilities end fraction space equals space ? space colon space 1

  • True or False?

    The acid test ratio is also known as the liquid capital ratio.

    True.

    The acid test ratio is also known as the liquid capital ratio.

  • Why is stock excluded from the acid test ratio?

    Stock is excluded in the acid test ratio because it is the least liquid form of current assets and may take time to sell, so would be of little use in meeting immediate financial obligations.

  • In the UK, what does a current ratio of 2:1 mean?

    A current ratio of 2:1 means a business has £2 of current assets to cover each £1 of short-term debt.

  • True or False?

    Increasing the credit period offered to customers can improve liquidity.

    False.

    Reducing the credit period offered to customers can improve liquidity by collecting money owed more quickly.

  • State one drawback of selling assets such as machinery or property, to improve liquidity?

    Drawbacks of selling assets to improve liquidity include:

    • It will worsen the balance sheet position of the business

    • Assets are no longer available for a business to use

  • What are drawings?

    Drawings are amounts of money withdrawn from a business by its owners.

Previous:3.4 Final AccountsNext: 3.6 Cash Flow

    1. Topic 1

      1.1 What is a Business?

    2. Topic 2

      1.2 Types of Business Entities

    3. Topic 3

      1.3 Business Objectives

    4. Topic 4

      1.4 Stakeholders

    5. Topic 5

      1.5 Growth & Evolution

    6. Topic 6

      1.6 Multinational Companies (MNCs)

    1. Topic 1

      2.1 Introduction to Human Resource Management

    2. Topic 2

      2.2 Organisational Structure

    3. Topic 3

      2.3 Leadership & Management

    4. Topic 4

      2.4 Motivation & Demotivation

    5. Topic 5

      2.5 Communication

    1. Topic 1

      3.1 Introduction to Finance

    2. Topic 2

      3.2 Sources of Finance

    3. Topic 3

      3.3 Costs & Revenues

    4. Topic 4

      3.4 Final Accounts

    5. Topic 5

      3.5 Profitability & Liquidity Ratio Analysis

    6. Topic 6

      3.6 Cash Flow

    7. Topic 7

      3.7 Investment Appraisal

    1. Topic 1

      4.1 Introduction to Marketing

    2. Topic 2

      4.2 Marketing Planning

    3. Topic 3

      4.3 Market Research

    4. Topic 4

      4.4 The Marketing Mix (7 P's)

    1. Topic 1

      5.1 Introduction to Operations Management

    2. Topic 2

      5.2 Operations Methods

    3. Topic 3

      5.3 Location

    4. Topic 4

      5.4 Break-even Analysis

    1. Topic 1

      6.1 The Business Management Toolkit