University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

190

Pages:

2
Author:

stud_ice13

1. Profit Margin The profit margin measures the percentage of net income generated from net sales. It indicates how much profit a company makes for every dollar of sales, providing insight into profitability. Formula: Profit Margin=Net IncomeNet Sales×100 Example Calculation: • If a company has a Net Income of $50,000 and Net Sales of $200,000: Profit Margin=50,000200,000×100=25% This means that for every dollar of sales, the company retains 25 cents as profit. Analysis: • • A higher profit margin indicates better efficiency in converting sales into actual profit. It suggests good control over costs and expenses. A lower profit margin may indicate high expenses relative to sales, or pricing that is not high enough to cover costs. 2. Current Ratio The current ratio measures a company’s ability to pay off its short-term obligations with its short-term assets. It is an important indicator of liquidity. Formula: Current Ratio=Current AssetsCurrent Liabilities Example Calculation: • If a company has Current Assets of $150,000 and Current Liabilities of $100,000: Current Ratio=150,000100,000=1.5 This means that the company has $1.50 in current assets for every $1.00 of current liabilities. Analysis: • • • A current ratio greater than 1 indicates that the company has more current assets than current liabilities, suggesting it is in a good position to cover its short-term debts. A current ratio less than 1 suggests that the company may have difficulty meeting its short-term obligations, which could be a sign of liquidity issues. Ratios close to 1 (like 1.2) indicate that the company can cover its liabilities but lacks a significant buffer, which could be risky if some assets are not easily converted to cash. Application to Business Decisions • • For Profit Margin: If a company aims to improve its profit margin, it can either increase revenues or cut costs. However, as noted in the example of cutting marketing expenses, this decision should consider long-term effects on sales and customer acquisition. For Current Ratio: A company with a current ratio below 1 might find it harder to secure loans or favorable terms from suppliers. Improving the current ratio could involve increasing current assets (e.g., cash or receivables) or reducing current liabilities.