Question

Briefly explain the difference between liquidity, solvency, and profitability analysis.

Answer 1

The Liquidity analysis basically measures the company`s ability to pay off its short term Obligations. It is the ability to convert current assets into cash quickly and cheaply E.g are:-

Current Ratio :- Current Assets/ Current Liability

Quick Ratio:- Cash+ Short term marketable Investments+ Receivables/ Current Liabilities

Solvency analysis basically measures the company`s ability to satisfy its long term obligations. The solvency analysis indicates whether a company`s cash flow is sufficient to meet its long term obligations.. The Solvency ratios are debt ratios and coverage Ratios i.e

- Debt to asset ration :- Total Debt/ Total Assets

- Financial Leverage Ratio :- Average Total Assets/Average total equity

Profitability Analysis- Profitability analysis measures a company`s ability to generate profits from its resources. This evaluates a company`s ability to generate company`s income against its expenses. Profitability analysis of the company is generally done by calculating the following:-

Gross Profit Margin :- Gross Profit/ Revenue

Operating Profit Margin :- Operating Profit/ Revenue

Pretax Margin :- Earning before tax but after Interest/ Revenue

Net Profit Margin :- Operating Income/Average Total Assets

Return on Assets, Return on total capital etc.