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3.5 PROFITABILITY & LIQUIDITY RATIO ANALYSIS (LIQUIDITY RATIOS ;…
3.5 PROFITABILITY & LIQUIDITY RATIO ANALYSIS
PROFITABILITY RATIOS
PROFIT MARGIN RATIOS
; used to assess and measure how successful the performance of the management of a business has been converting sales revenue into gross profit and net profit
GROSS PROFIT MARGIN
NET PROFIT MARGIN
STRATEGIES TO IMPROVE
Increase gross and net profit margin by reducing direct costs
use cheaper materials
cut labour costs
cut wage costs
Increase gross and net profit margin
increasing price of product
Increase net profit margin
reducing overhead costs
move to a cheaper office location
reduce promotion costs
delayering the organisation
RETURN ON CAPITAL EMPLOYED
; the most commonly used means of assessing the profitability of a business
STRATEGIES FOR INCREASING ROCE
Increase net profit without increasing capital employed
raise prices of existing products
develop innovative products and set high price
reduce variable costs per unit
reduce overheads
increase capital invested in new technology
Reduce capital employed
sell assets that contribute nothing/little to sales/profit
LIQUIDITY RATIOS
; assess the ability of the firm to pay its short-term debts
CURRENT RATIO
ACID TEST RATIO
give a clearer picture of the firm's ability to pay short-term debts by eliminating the value of stocks from the acid-test ratio
STRATEGIES FOR IMPROVING LIQUIDITY RATIOS
sell off fixed assets for cash
sell off inventories for cash
increase loans to inject cash into the business and increase working capital