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3.5 Profitability and liquidity ratio analysis

3.5 Profitability and liquidity ratio analysis

Learning outcomes

This section of the syllabus examines the role of ratio analysis for financial strategic analysis. It requires students to understand the purpose and use of financial ratios, including how to calculate and interpret profitability and liquidity ratios. Students also need to examine the various strategies that can be used to improve a firm's profitability, efficiency, and liquidity ratios.

Ratio analysis is a financial analysis tool used in the interpretation and assessment of an organization's final accounts, i.e. the firm's financial statements, consisting of the balance sheet and income statement ( profit and loss account). Such analysis helps decision-makers and other stakeholders to evaluate a business organization's financial performance by exposing various financial strengths and weaknesses. Finally, ratio analysis helps to make meaningful historical and inter-firm comparisons by analysing past data of the business, and those of other businesses in the same (or even different) industries for benchmarking purposes.

The learning outcomes (or assessment objectives) for this section of the syllabus are:

  • The following profitability and efficiency ratios* (AO2, AO4):
    • gross profit margin (GPM)
    • net profit margin (NPM)
    • return on capital employed (ROCE)*

  • Possible strategies to improve these profitability, efficiency, and liquidity ratios ratios (AO3)

  • The following liquidity ratios AO2, AO4:
    • current
    • acid-test / quick

  • Possible strategies to improve these liquidity ratios (AO3)

*Note: The ROCE ratio appears in this section of the IB Business Management syllabus - it is an efficiency ratio which both SL and HL students need to learn. There are four additional additional efficiency ratios that HL students need to learn (see Unit 3.6).

InThinking Business Management resources

Click the hyperlinks below to access the InThinking resources for this particular section of the IB Business Management syllabus.

Other resources

Watch this 7-minute introductory video about ratio analysis and its purposes. Be aware that this video was not produced specifically for the IB so make sure you stick to the ratios in the IB guide.

For additional exercises and quantitative practice questions (and answers), I would also recommend these two excellent resources:

  • 55 Quantitative Worksheets & Answers Pack, available from Level7 Education

  • Business Management for the IB Diploma Quantitative Skills Workbook, available from Hodder Education.

Click here to return to the Unit 3 Finance and accounts homepage

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