Profitability and Liquidity Ratios Quiz

Understanding Profitability and Liquidity Ratios

• Profit is the money remaining after all costs and expenses are paid, vital for business operations
• Profitability is a measure of the profit made relative to sales achieved and capital invested, typically measured as a percentage
• Profitability ratios are used by investors, directors, and managers to assess business success and efficiency
• Gross Profit Margin (GPM) measures the efficiency of sales and cost of goods sold, limited as it does not consider other expenses
• Operating Profit Margin (OPM) considers all expenses, indicating the success of managers in making net profit from sales
• Return on Capital Employed (ROCE) shows how efficiently businesses make profit from the capital employed, desired to increase year on year
• Liquidity refers to a business's ability to buy, sell, and raise cash, crucial for paying short-term debts
• The Current Ratio assesses a business's ability to pay debts, with a ratio between 1.0-3.0 considered positive
• The Acid Test Ratio adjusts the Current Ratio to eliminate certain current assets not in cash form, a ratio below 1 is unfavorable
• Stakeholders such as creditors, banks, government, employees, and trade unions use ratio analysis information
• Limitations of ratio analysis include reliance on past accounting data, not accounting for external factors like inflation, and differences in accounting methods
• Ratio analysis is essential for understanding a business's profitability and liquidity, but it should be used in conjunction with other information and factors.