Profitability and Liquidity Ratio Analysis
1.5 Profitability and Liquidity Ratio Analysis
Financial ratios are tools used to analyze a company's financial health. They allow managers and investors to compare performance over time or with other businesses. Two major categories of ratios studied in IB Business Management are profitability ratios and liquidity ratios.
Profitability Ratios
Gross Profit Margin = (Gross Profit ÷ Revenue) × 100
Indicates the percentage of revenue remaining after production costs. Higher margins indicate efficient production and pricing strategies.
Net Profit Margin = (Net Profit ÷ Revenue) × 100
Shows the business's overall profitability after all expenses. A rising net profit margin indicates improved financial performance.
Liquidity Ratios
Current Ratio = Current Assets ÷ Current Liabilities
A ratio above 1 usually indicates that the business can meet short-term debts.
Quick Ratio (Acid Test) = (Current Assets − Inventory) ÷ Current Liabilities
This ratio provides a stricter measure of liquidity by excluding inventory. Liquidity is important because even profitable businesses can fail if they run out of cash.