Profitability and liquidity ratios
Profitability ratios
- Ratio analysis links two figures to judge performance and compare years/firms.
$$\text{gross profit margin} = \frac{\text{gross profit}}{\text{revenue}} \times 100\%$$
$$\text{ROCE} = \frac{\text{operating profit}}{\text{capital employed}} \times 100\%$$
- A higher margin keeps more profit per sale; a higher ROCE means money is used well.
Practice
Gross profit is 30,000 and revenue is 120,000. What is the gross profit margin (%)?
Gross profit margin = 30,000 ÷ 120,000 × 100% = 25%.
Practice
A higher ROCE means:
ROCE compares operating profit with capital employed; higher = better use of the money invested.
Liquidity ratios
$$\text{current ratio} = \frac{\text{current assets}}{\text{current liabilities}}$$
$$\text{acid test} = \frac{\text{current assets} - \text{inventory}}{\text{current liabilities}}$$
- A current ratio of ~1.5–2 is usually safe. The acid test is stricter (removes slow-selling inventory).
Practice
Current assets are 60,000 and current liabilities are 30,000. What is the current ratio? (give the number, e.g. 2)
Current ratio = current assets ÷ current liabilities = 60,000 ÷ 30,000 = 2.
You've got it
Key idea
- gross profit margin = gross profit ÷ revenue × 100%; ROCE = operating profit ÷ capital employed × 100%
- current ratio = current assets ÷ current liabilities (~1.5–2 safe)
- the acid test removes inventory — a stricter liquidity check