Profitability and liquidity ratios
Introduced| English | Meaning |
|---|---|
| profitability/ˌprɒfɪtəˈbɪlɪti/ | The ability of a business to generate profit in relation to its sales, costs, assets or investment. |
| liquidity/lɪˈkwɪdɪti/ | The ease of converting assets into cash without substantial loss, or the ability to meet short-term payment obligations. |
| gross profit margin/ɡrəʊs ˈprɒfɪt ˈmɑːdʒɪn/ | Gross profit expressed as a percentage of sales revenue. |
| ROCE/ˌɑː əʊ siː ˈiː/ | Operating profit ÷ capital employed × 100 — the key return measure. |
| capital employed/ˈkæpɪtl emˈplɔɪd/ | The long-term funds used in a business, commonly measured as total assets minus current liabilities. |
| operating margin/ˈɒpəreɪtɪŋ ˈmɑːdʒɪn/ | operating margin |
| current ratio/ˈkʌrənt ˈreɪʃɪəʊ/ | Current assets divided by current liabilities, used as an indicator of short-term liquidity. |
| acid-test ratio/ˈæsɪd test ˈreɪʃɪəʊ/ | acid-test ratio |
Reading between the lines
- Raw profit figures don't tell you if a business is doing well relative to its size. Ratios do.
- Two families matter most: profitability 盈利能力 and liquidity 流动性.
Accounts ratio diagnosis
Classify ratios by the question they answer about a business.
Gross profit is 90 and revenue is 300. What is the gross profit margin (%)?
Difficulty 2/5 · 140 coins + a small bonus on first completion today
90 ÷ 300 × 100 = 30%.
Operating profit is 40 and capital employed is 200. What is ROCE (%)?
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40 ÷ 200 × 100 = 20%.
Profitability ratios
- Gross profit margin 毛利率 = gross profit ÷ revenue × 100.
- Operating (net) profit margin = operating profit ÷ revenue × 100.
- ROCE 已动用资本回报率 = operating profit ÷ capital employed 所用资本 × 100 — the key return measure.
Worked example. Operating profit 30, revenue 200 → operating margin 营业利润率 = 30 ÷ 200 × 100 = 15%. With capital employed of 150, ROCE = 30 ÷ 150 × 100 = 20%.
An income statement falls from revenue down to net profit
Current assets are 120 and current liabilities are 60. What is the current ratio?
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120 ÷ 60 = 2 (i.e. 2:1).
The liquidity ratio that excludes inventory is the ______-test ratio.
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Acid-test = (current assets − inventory) ÷ current liabilities.
Liquidity ratios
- Current ratio 流动比率 = current assets ÷ current liabilities (around 1.5–2 is healthy).
- Acid-test ratio 速动比率 = (current assets − inventory) ÷ current liabilities — a stricter test.
A profitable business can still have poor liquidity if its cash is tied up in stock and debtors.
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Profit and cash are different — check liquidity separately.
What the ratios reveal
- Profitability ratios show how well the firm turns sales and capital into profit.
- Liquidity ratios show whether it can pay its short-term debts.
High profit doesn't guarantee good liquidity. A firm can be very profitable yet unable to pay this month's bills if its cash is tied up in stock or unpaid invoices. Check both ratio types.
You've got it
- profitability: gross margin, operating margin, and ROCE (operating profit ÷ capital employed)
- liquidity: current ratio and the stricter acid-test (excludes inventory)
- profitability and liquidity are different — a profitable firm can still run short of cash
Write from a gross margin of 32 percent
- Gross profit is 64 and revenue is 200. Operating profit is 18 and capital employed is 120. Current assets are 90 and current liabilities are 30.
- Find the gross margin, ROCE and the current ratio.
Gross profit is 64 and revenue is 200. Operating profit is 18 and capital employed is 120. Current assets are 90 and current liabilities are 30. What are the gross profit margin, ROCE and the current ratio?
64 over 200 is 32 percent. 18 over 120 is 15 percent. 90 over 30 is 3.
What is the current ratio?
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Current assets divided by current liabilities is 3. Other options — 2 (the lesson current ratio); 32 (the gross margin used as the ratio).