Question

Assess the key ratios for profitability, liquidity, and solvency used by financial analysts to evaluate the financial performance of a company. Next, indicate one (1) ratio from each of the three (3) categories (profitability, liquidity, and solvency) that you believe to be most indicative of future performance. Use actual ratios from a company of your choice to provide support for your rationale.

Answer 1

Ratios- Are the indicators of financial performance of a company, these are in numbers that tell relationship between two elements.

Profitability ratios- Are calculated and used to measure how much, a company is profitable in its existing product or service. Examples:

• Gross profit margin = Gross profit / Sales
• Net profit margin = Net profit / Sales
• ROE = Net profit / Shareholder's equity
• ROA = Net profit / Total assets

Liquidity ratios- Are calculated and used to measure how much, a company is liquid and can it meet its short term capital needs and obligation. Examples:

• Current ratio = Current assets / Current liabilities
• Quick ratio = Liquid assets / Current liabilities

Solvency ratios- Are calculated and used to know whether a company is able to meet its long term obligation (debt). Examples:

• Debt-Equity ratio = Total liabilities / Total Assets
• Interest coverage ratio = EBIT / Total Interest

I am taking Apple Inc. and its ratios are:

Profitability: Its net profit margin is 22.41% (as on Sep. 2018). It shows that company is profitable.

I have taken this ratio because net profit is calculated after deducting all the expenditures including interest and tax.

Liquidity: Its current ratio is 1.30 (as on Dec. 2018). It shows that company is liquid. Ratio above 1 is good. Current ratio is the best measure of liquidity, it takes into account all the current assets.

Solvency: Its debt to equity ratio is 1.07 (as on Sep. 2018). It shows that company has heavy debt. Ratio below .50 is good.

Debt equity is very important ratio to show the percentage of debt and equity in the company.