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3.5 Profitability and liquidity ratio analysis (Liquidity Ratio (strategy…
3.5 Profitability and liquidity ratio analysis
Profitability Ratio
Profit margin ratios
gross profit margin
= gross profit/sales revenues x 100
net profit margin
net profit/sales revenues x 100
use to asses how successful the business
measure performance of firm
strategy to increase profit margin
increase gross and net profit margin by reducing direct costs
increase gross and net profit by increasing price
increase net profit margin by reducing overhead costs
Return on Capital Employed (ROCE)
= net profit/ capital employed x 100
how to increase
raise prices of existing products
develop innovative products
reduce variable cost
reduces overhead
reduce capital employed
Liquidity Ratio
Ability of the firm to pay its debt in shorterm
Current ratio
= currents assets / current liabilities
results over 2 might suggest too many funds are tied up
Acid test ratio
= liquid assets/ current liabilities
eliminate value of stocks
strategy to increase
sell off fixed assets for cash - could lease these back if still needed by the business
sell off inventories - improve acid test ratio but not current ratio
increase loans to inject cash - increase working capital