Exam code: 0450, 0986 & 0264, 0774
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Define profitability.
Profitability is the ability of a business to generate profit compared to revenue, assets, or capital invested.
What does return on capital employed (ROCE) measure in a business?
Return on capital employed (ROCE) measures how effectively a business uses the capital invested to generate profit.
The gross profit margin is calculated as divided by sales revenue, multiplied by 100.
The gross profit margin is calculated as gross profit divided by sales revenue, multiplied by 100.
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Define profitability.
Profitability is the ability of a business to generate profit compared to revenue, assets, or capital invested.
What does return on capital employed (ROCE) measure in a business?
Return on capital employed (ROCE) measures how effectively a business uses the capital invested to generate profit.
The gross profit margin is calculated as divided by sales revenue, multiplied by 100.
The gross profit margin is calculated as gross profit divided by sales revenue, multiplied by 100.
Define profit margin.
The profit margin shows the proportion of revenue turned into profit before interest and tax, expressed as a percentage.
True or False?
ROCE is most useful when comparing businesses in the same industry.
True.
ROCE is less useful for comparing businesses in contrasting industries, but valuable for same-industry comparisons.
What does a higher gross profit margin indicate about a business?
A higher gross profit margin indicates the business is effectively adding value and turning more revenue into gross profit.
Profit margin is calculated as profit divided by , multiplied by 100.
Profit margin is calculated as profit divided by sales revenue, multiplied by 100.
Which stakeholders are interested in profitability and why?
Investors, directors, managers, and employees are interested in profitability, as it affects investment decisions, business strategy, and wage negotiations.
To improve ROCE, a business can increase profit without introducing new capital, or maintain profit while the amount of capital employed.
To improve ROCE, a business can increase profit without introducing new capital, or maintain profit while reducing the amount of capital employed.
State two ways a business can improve its profit margin.
A business can improve its profit margin by increasing its gross profit margin or by reducing overhead costs.
Define liquidity.
Liquidity is the amount of cash and other current assets a business has available to quickly pay bills and meet short-term financial obligations.
What is the current ratio?
The current ratio indicates how many units of current assets are available to cover each unit of short-term debt. It is a quick way to measure liquidity and is expressed as a ratio.
What is the acid test ratio?
The acid test ratio (also called the quick ratio) measures a business’s liquidity by showing how easily it can pay its short-term debts without relying on selling inventory.
What does it mean if a business is insolvent?
If a business is insolvent, it means it cannot pay its debts as they fall due.
Which formula is used to calculate the current ratio?
The current ratio is calculated as current assets ÷ current liabilities. The result is expressed as a ratio (e.g., 3.07 : 1).
What is excluded from the acid test ratio calculation and why?
Inventory (stock) is excluded from the acid test ratio because it is the least liquid current asset and may take time to sell, so the ratio gives a more realistic measure of a business’s ability to meet short-term debts quickly.
True or False?
The liquidity of a business can only be measured using the current ratio.
False.
Liquidity can be measured using both the current ratio and the acid test ratio.
What does a current ratio of 2.18 : 1 mean for a business?
A current ratio of 2.18: 1 means the business has £2.18 of current assets to cover every £1 of short-term debt.
Which formula is used to calculate the acid test ratio?
The acid test ratio is calculated as (current assets – inventory) ÷ current liabilities. The result is expressed as a ratio (e.g., 1.44 : 1).
True or False?
The acid test ratio is also known as the liquid capital ratio.
True.
The acid test ratio is also called the liquid capital ratio.
Define internal stakeholders.
Internal stakeholders are individuals or groups within a business who use financial accounts to help make decisions, such as owners, managers, and employees.
How do shareholders use a company’s financial accounts?
Shareholders use financial accounts to assess profitability, decide whether to keep or sell shares, and determine if dividends can be paid.
What are audited accounts?
Audited accounts are financial statements reviewed and verified by independent auditors to ensure accuracy and compliance, required for public limited companies before publication.
True or False?
Managers use financial accounts and ratio analysis to help set targets and identify business problems.
True.
Managers rely on financial accounts and ratio analysis to measure performance, set targets, and identify problems such as falling liquidity or high debts.
True or False?
Financial ratios can help compare business performance over time.
True.
Ratios turn financial data into useful tools for spotting strengths, weaknesses, and making year-to-year or business-to-business comparisons.
Why can decisions based only on financial accounts be misleading?
Financial accounts may not explain why figures changed and miss non-financial factors like employee motivation, customer satisfaction, or product quality.
True or False?
Businesses might manipulate their accounts to appear more successful than they are.
True.
Businesses can delay payments or hide debts to make their financial position look better, which can result in poor decisions if the data is false or adjusted.
How do suppliers use a business’s financial accounts?
Suppliers use financial accounts, especially current ratios, to check if a business can pay its bills and decide whether to offer trade credit.