3.5 Profitability & Liquidity Ratio Analysis

Profitability Ratios

Liquidity Ratios

Ratio Analysis

Efficiency Ratios

Liquidity Ratios

Profitability Ratios

Organisation earning more than paying out?

Organisation making best use of its resources?

Organisation have enough £ pay bills?

Why Ratio Analysis is Useful???

Compare current years performance with prev. years

Compare performance with competitors

Interpret info. to how to improve in future

Use info. for forecasting/budgeting

Provide info. to access finance sources

Assist in decision-making process

Profit is Absolute Measure BUT Profitability is Relative Measure

Measured with profitability ratios

P R O F I T A B I L I T Y

how profitable business is

measure overall performance

used to assess current performance of business, comparing to:

Past Records

Other similar businesses

Average PR of sector business operates in

Formulas: IMAGE 1

GPM

HOW TO IMPROVE BOTH GPM & PM (Ways -> Limitations)

GP = Sales Rev. - Cost of Goods Sold

Profit before indirect expenses accounted

Always % shown represents sales by GP

GPM Evaluation

GPM rising possibly because:

GPM falling possibly because:

Higher GPM the better

Increase in Production Costs

Decrease in price

Loss of stock - wasn't sold

Increase in products selling price

Increase in sales volume

Reduction in Production Costs

PM

Gross Profit - Indirect Costs = Profit

Shows % of sales represented by net profit

Higher PM the better

PM Evaluation

PM falling possibly because:

PM rising possibly because:

Increase in Production Cost = GP Decreases

Decrease in Price = Less Sales Rev.

Loss of Stock - not sold

Increasing Overhead Expenses/Indirect Costs

Increase in Products Selling Price = Inc. Sales Rev.

Inc. Sales Volume = Inc. Sales Rev

Reduction Production Costs = Inc. GP

Reduction in Overhead Costs

Increase selling price

Quantity sold may dec. -> no changes on sales rev. Depends price elasticity of product

Dec. cost of goods sold (so inc. GP)

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Dec. Overhead/ Expenses (only PM)

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