The
gross profit margin ratio
compares an entity’s gross profit to its sales revenue,
reflecting the proportion of sales revenue that results in gross profit.
Example:
Gross profit
x 100 =
x
%
Sales revenue
Gross profit margin

22
Profitability analysis
continued
Net profit margin ratio revels entity’s ability to produce profit from each dollar of
sales.
Profit margin computed with profit (loss) as the numerator, may use EBIT
Example:
Net Profit
x 100 =
x
%
Sales revenue
Net profit margin

23
Activity 4

24
Activity 5

25
Activity 6

26
Asset efficiency analysis
Asset turnover ratio
Shows an entity’s overall efficiency in generating income per dollar of investments
in assets
Value will depend on the efficiency with which it manages its current and non-
current investments
Example:
Sales revenue
=
x
times
Average total
assets
Asset turnover ratio

27
Asset efficiency analysis
continued
Inventory turnover period (Days)
indicates the average period of time it
takes to sell inventory
Inventory turnover (Times)
can be calculated in
terms
of the number of
times in a year the inventory is replaced in the business. In this case the
ratio in calculated as:
Example:
Average inventory
x 365 =
x
days
Cost of sales
Inventory turnover
Cost of sales
=
x
times
Average inventory
Times inventory turnover

28
Asset efficiency analysis
continued
Debtors turnover ratio (Days)
indicates average period of days it takes to
collect the money from its trade related accounts receivable
Debtors turnover (Times)
can be calculated in
terms
of the number of times
in a year the business collect the money from its trade debtors. In this case
the ratio in calculated as:
Example:
Average accounts receivable
x 365 =
x
days
Sales revenue
Debtors turnover (days)
Sales revenue
=
x
times
Average accounts receivable
Debtors turnover (times)

29
Asset efficiency analysis
continued
Days inventory and days debtors turnovers can be considered together to reflect the
entity’s
activity cycle
(also referred to as the
operating cycle
)
A period of time (
cash cycle
) elapses between an entity paying for the inventory,
selling the inventory, and receiving cash for the inventory

30
Liquidity analysis
The survival of the entity depends on its ability to pay its
short terms debts when they fall due (its
liquidity
)
An entity must have sufficient
working capital
to satisfy
its short-term requirements and obligations
But excess working capital is undesirable because the
funds could be invested in other assets that would
generate higher returns

31
Liquidity analysis
continued
Current ratio and quick ratio
Current ratio
(or working capital ratio) indicates $ of current
assets per $ of current liabilities
Example:
Current assets
=
x
times
Current liabilities
Current ratio

32
Liquidity analysis
continued
Quick asset ratio
(or acid test ratio) measures $ of current
assets available (excluding inventory) to service each $ of
current liabilities
Example:
Current assets – inventory
=
x
times
Current liabilities
Quick asset ratio

33
Liquidity analysis
continued
Cash flow ratio

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