Question

4. Explain what the following ratios communicate about the business.

a. Gross profit margin (2 marks)

b. Operating profit margin (2 marks)

c. Return on assets (ROA) (2 marks)

d. Return on equity (ROE) (2 marks)

e. Gearing ratio (2 marks)

f. Inventory turnover (2 marks)

g. Interest coverage ratio (2 marks)

h. Earnings per share (2 marks)

i. Price earnings ratio (2 marks)

j. Dividend yield (2 marks)

k. Dividend payout ratio (2 marks)

l. Net working capital (2 marks)

m. Current ratio (2 marks)

n. Quick ratio (2 marks)

o. Debt to equity ratio (2 marks)

Answer 1

Gross Profit Margin

Gross profit Margin indicates percentage of funds remaining after removing the cost of goods sold from the revenue figures. The higher the gross profit margin percentage, the more funds are available to reinvest, save and/or pay expenses.

Operating profit margin

Operating profit margin reveals the financial viability of the core operations of a business before any extraneous financial or tax-related effects. The operating profit margin is the earnings that a business generates from its operating activities. Operating profit is then divided by revenues to arrive at the operating profit margin percentage.

Return on assets (ROA)

The return on assets (ROA) shows the percentage of how profitable a company's assets are in generating revenue. ROA=Net Income/Average Total Assets. Generally 5% is considered good.

Return on equity

Return on equity measures the profitability of a business in relation to the equity, also known as net assets or assets minus liabilities. ROE is a measure of how well a company uses investments to generate earnings growth. ROE=Net Income/Equity.

Gearing Ratio

Gearing (%) = Long Term Liabilities/Capital Employed. A gearing ratio is a general classification describing a financial ratio that compares some form of owner equity (or capital) to funds borrowed by the company.

Inventory turnover

Inventory turnover is a measure of the number of times inventory is sold or used in a time period. Inventory Turnover=Net Sales/Average Inventory.

Interest coverage ratio

Interest coverage ratio, also known as times interest earned. The interest coverage ratio is a financial ratio that measures a company's ability to make interest payments on its debt in a timely manner.

Earnings per share

Earnings per share (EPS) is calculated as a company's profit divided by the outstanding shares. The earnings per share metric are one of the most important variables in determining a share's price. It is also a major component used to calculate the price-to-earnings (P/E) valuation ratio, where the E in P/E refers to EPS

Price earnings ratio

The price-earnings ratio is the ratio of a company's share (stock) price to the company's earnings per share. P/E=Share Price/Earnings Per Share.

Dividend Yield

The dividend yield is the ratio of a company's annual dividend compared to its share price.Dividend Yield=Annual Dividend/Share Price.

Dividend payout ratio

The dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends. Dividend Payout Ratio=Dividends/Net Income.

Net Working Capital

Net working capital = Current assets minus Current liabilities. Net working capital is the amount (as opposed to being a ratio) remaining after subtracting a company's total amount of current liabilities from its total amount of current assets.

Current Ratio

The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year. The current ratio is sometimes referred to as the “working capital” ratio and helps investors understand more about a company’s ability to cover its short-term debt with its current assets. Current Ratio=Current Assets/Current Liabilities.

Quick Ratio

The quick ratio is an indicator of a company’s short-term liquidity position and measures a company’s ability to meet its short-term obligations with its most liquid assets. it is also called the acid test ratio.

Debt to Equity Ratio

The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. The debt to equity ratio shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders).