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Profitability ratios
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Ratios turn financial statements into numbers that are easy to compare. Profitability ratios show how well a business makes profit.
Profitability versus liquidity
Profitability is the ability to make profit from sales and from the money invested.
Liquidity is the ability to pay short-term debts when they are due.
A business can be profitable but short of cash, or have plenty of cash but make little profit.
Liquidity is the ability to pay short-term debts when they are due.
A business can be profitable but short of cash, or have plenty of cash but make little profit.
The ratios
Gross profit percentage = gross profit ÷ revenue × 100
Profit for the year as a percentage of revenue = profit for the year ÷ revenue × 100
Return on capital employed (ROCE) = profit for the year ÷ capital employed × 100
Capital employed is the long-term finance used: the owner's capital plus any non-current liabilities.
Profit for the year as a percentage of revenue = profit for the year ÷ revenue × 100
Return on capital employed (ROCE) = profit for the year ÷ capital employed × 100
Capital employed is the long-term finance used: the owner's capital plus any non-current liabilities.
Interpreting
Compare with last year and with similar businesses.
A falling gross profit percentage may mean lower selling prices or higher purchase costs.
If gross profit percentage is steady but profit for the year percentage falls, expenses have risen.
A ROCE lower than interest from a bank suggests the capital could earn more elsewhere.
A falling gross profit percentage may mean lower selling prices or higher purchase costs.
If gross profit percentage is steady but profit for the year percentage falls, expenses have risen.
A ROCE lower than interest from a bank suggests the capital could earn more elsewhere.
Revenue £200 000, gross profit £70 000, profit for the year £24 000. Find the gross profit percentage and profit for the year as a percentage of revenue.
- GP% = 70 000 ÷ 200 000 × 100 = 35%
- PFY% = 24 000 ÷ 200 000 × 100 = 12%
Answer: 35% and 12%
Profitability: making profit. Liquidity: paying short-term debts. GP% = GP ÷ revenue × 100. Profit for the year % = profit ÷ revenue × 100. ROCE = profit for the year ÷ capital employed × 100. Compare over time and with rivals.
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