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3.5 PROFITABILITY AND LIQUIDITY RATIO ANALYSIS (STRATEGIES TO INCREASE…
3.5 PROFITABILITY AND LIQUIDITY RATIO ANALYSIS
PROFITABILITY RATIOS
Profit margin ratios
Used to assess how successful the mgmt of biz converting sales revenue into gross & net profit
GROSS PROFIT MARGIN
(gross profit / sales revenue) x 100
A good indicator of how effectively managers have added value to cost of sales
NET PROFIT MARGIN
The differences between the margin is the cost of overheads
(net profit / sales revenue) x 100
LIQUIDITY RATIOS
Liquidity
: the ability of a firm to pay its short-term debts
not concerned with the profit but the working capital
CURRENT RATIO
current assets / current liabilitites
ACID TEST RATIO
(quick ratio)
liquid assets / current liabilities
(stricter test)
liquid assets
= current assets - inventories
STRATEGIES TO INCREASE PROFIT MARGINS
Increase the gross & net profit margin by reducing direct costs - cutting the cost of goods sold
Increase productivity
Cut wage costs
Cut labour costs
Increase net profit margin by reducing overhead costs
Reduce rent, promotion
Delaying the organisation
Increase gross & net profit margin by increasing price
Bcos of trends
Raise price without increase in variable costs
ROCE
Most commonly used means of assessing the profitability of a business @ primary efficiency ratio
(net profit / capital employed) x 100
Strategies for increasing ROCE
Reduce overheads
Develop innovative products and set prices high
Increase capital invested in new technology
Raise prices of existing products
Reduce capital employed
STRATEGIES FOR IMPROVING LIQUIDITY RATIOS
Sell off inventories for cash
improve acid test ratio, but not current ratio
Increase loans to inject cash
increase working capital
Sell off fixed assets for cash
could lease back if still needed by the business