Business Profitability Indicators

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Questions and Answers

What does profitability indicate in a business context?

The ability to continue operations in the long term
The ability to make a profit compared to sales or equity (correct)
The ability to pay short-term debts
The ability to manage assets and generate revenue

Which of the following best describes liquidity in a business?

The ability to achieve high net profit margins
The capability to efficiently utilize assets for revenue generation
The potential for long-term operational stability
The ability to meet short-term debts as they come due (correct)

What aspect does asset turnover efficiency primarily relate to?

Gross profit calculation
Long-term debt obligations
Short-term liquidity management
Profitability and resource management (correct)

Which indicator specifically expresses profit in relation to sales revenue?

Net Profit Margin (C) Signup and view all the answers

What does the concept of stability/gearing in a business refer to?

The ability to meet long-term debts and sustain operations (D) Signup and view all the answers

What does the Asset Turnover (ATO) indicate?

The efficiency of asset utilization to generate revenue (B) Signup and view all the answers

Which of the following is a formula for calculating net sales?

Net Sales = Sales - Sales Return (A) Signup and view all the answers

What is one of the components used to analyze Return on Assets (ROA)?

Trends and budgets analysis (D) Signup and view all the answers

What does a high Gross Profit Margin indicate?

Low cost of goods sold relative to sales (D) Signup and view all the answers

Which statement best describes Return on Owner's Investment (ROI)?

It assesses the effectiveness of owner's equity utilization to generate profit (A) Signup and view all the answers

What does the expense ratio measure?

The proportion of costs to total revenue (D) Signup and view all the answers

Which scenario would likely indicate favorable trends in a business's ROI?

A rise in net profit relative to invested capital (C) Signup and view all the answers

What financial aspect is crucial for a trading business to ensure survival?

Sufficient liquid funds (C) Signup and view all the answers

What does the Working Capital Ratio (WCR) analyze?

The relationship between current assets and current liabilities (A) Signup and view all the answers

A Working Capital Ratio of less than 1:1 indicates what?

Current liabilities exceed current assets (A) Signup and view all the answers

Which of the following ratios is also known for analyzing the speed of liquidity?

Inventory Turnover (A) Signup and view all the answers

What is the Cash Cycle composed of?

Inventory Turnover and Accounts Receivable Turnover (C) Signup and view all the answers

How is the Cash Flow Cover (CFC) generally analyzed?

By comparing cash flow to liabilities (B) Signup and view all the answers

What does the term 'gearing' refer to in a business context?

The reliance on external funding compared to owner contributions (B) Signup and view all the answers

Which factor contributes to a business's efficiency?

Effective management of assets and liabilities (B) Signup and view all the answers

If a company has a very high Working Capital Ratio, it may indicate which of the following?

Asset utilization might be inefficient (B) Signup and view all the answers

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Study Notes

Profitability

Profitability is the ability of a business to make a profit compared to a base such as sales, assets, or owner's equity.
Profitability indicators measure profit in relation to other aspects of business performance.
Net profit margin measures the percentage of sales revenue retained as net profit, reflecting expense control.
- Analyze trends, compare to benchmarks, and consider industry averages.
- Strategies to improve net profit margin include reducing costs and increasing sales.
- A higher net profit margin is generally considered better, indicating greater profitability.
Gross profit margin measures the percentage of sales revenue remaining after deducting the cost of goods sold.
- Analyze trends, compare to benchmarks, and consider industry averages.
- Strategies to improve gross profit margin include negotiating better prices for materials and reducing production costs.
- A higher gross profit margin is generally considered better, indicating greater profitability.
Asset turnover measures how efficiently a business uses its assets to generate revenue, for every dollar invested in assets, x cents of sales revenue is generated.
- Analyze trends, compare to industry benchmarks, and consider the company's size and industry.
- Strategies to improve asset turnover include optimizing asset usage and reducing idle assets.
- A higher asset turnover generally indicates greater efficiency in asset utilization.
Return on assets (ROA) measures the profitability of a business in relation to its assets.
- Analyze trends, compare to benchmarks, and consider industry averages.
- Strategies to improve ROA include increasing profitability and reducing assets employed.
- A higher ROA generally indicates better profitability in relation to the assets employed.
Return on Investment (ROI) measures the profitability of an investment, comparing the gain or loss from an investment relative to the amount invested
- Analyze trends, compare to benchmarks, and consider investment goals and risk.
- Strategies to improve ROI include increasing returns and reducing costs.
- A higher ROI generally indicates a more successful investment.
Expense Ratio measures expense as a percentage of revenue.

Liquidity

Liquidity is the ability of a business to meet its short-term debt as it falls due.
Working Capital Ratio (WCR) measures a business's ability to pay off its short-term liabilities using its current assets
- Analyze trends, compare to industry benchmarks, and consider company size and industry.
- Strategies to improve WCR include increasing current assets and reducing current liabilities.
- A WCR of 1:1 is generally desirable, indicating a balance between current assets and current liabilities.
Quick Asset Ratio (QAR) measures a business's ability to pay off its short-term liabilities using its liquid assets
- Analyze trends, compare to industry benchmarks, and consider company size and industry.
- Strategies to improve QAR include optimizing liquid assets and reducing current liabilities.
Cash Flow Cover (CFC) measures a business's ability to generate enough cash to cover its short-term debts.
- Analyze trends, compare to industry benchmarks, and consider company size and industry.
- A CFC of 1 or greater is generally considered desirable, indicating sufficient cash flow.

Efficiency

Efficiency is the ability of a business to manage the use of its assets and liabilities, the speed of liquidity.
- Strategies to improve efficiency include optimizing asset utilization, minimizing waste, and improving operational processes.
Inventory Turnover measures how efficiently a business sells its inventory, the speed of goods being sold.
Accounts Receivable Turnover measures how efficiently a business collects its receivables.
Accounts Payable Turnover measures how efficiently a business pays its suppliers.
Cash Cycle measures the time it takes to convert raw materials into cash from sales, combining the inventory turnover and accounts receivable turnover.

Stability/Gearing

Stability/Gearing measures a business's long-term financial health and reliance on borrowed funds.
Gearing is the dependence of a business on outside funds, compared to internal funds.