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3.5 Glossary of key terms

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  • Unit 3 - Finance/
  • 3.5 Profitability & liquidity ratio analysis/
  • 3.5 Glossary of key terms

Unit 3.5 Glossary of key terms - Profitability and liquidity ratio analysis

 

Key term

Definition

Acid test ratio

Also known as the quick ratio, this short-term liquidity ratio measures an organization’s ability to pay its short-term debts without having to sell any stock (inventories).

Capital employed

The value of all sources of finance for a business, including internal and external finance.

Current ratio

A short-term liquidity ratio used to calculate the ability of an organization to meet its short-term debts (within the next twelve months of the balance sheet date).

Gross profit margin (GPM)

A profitability ratio that measures an organization’s gross profit expressed as a percentage of its sales revenue. It is also an indicator of how well a business can manage its direct costs of production.

Liquidity

Refers to the ease with which a business can convert its assets into cash without affecting its market value, i.e., it measures a firm’s ability to repay short-term liabilities without having to use external sources of finance.

Liquidity ratios

These are financial ratios that examine an organization’s ability to pay its short-term liabilities and debts, namely the current and acid test ratios.

Profit

The financial surplus after all costs, including expenses, have been paid.

Profit margin ratio

A profitability ratio that measures a firm’s overall profit (after all costs of production have been deducted) as a percentage of its sales revenue. It is also an indicator of how well a business can manage its indirect costs (overhead expenses).

Ratio analysis

A quantitative management planning and decision-making tool, used to analyse and evaluate the financial performance of a business. These can be further categorised as profitability, liquidity, and efficiency ratio analysis.

Return on capital employed (ROCE)

A profitability ratio that measures a firm’s efficiency and profitability in relation to its size (as measured by the value of the organization’s capital employed).

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