Question

There are three broad categories of financial ratios: liquidity, solvency, and profitability. Discuss what each category reveals about the company being analyzed. Give examples of ratios that are affected by inventory, and discuss changes a manager might make to improve the financial ratio.

Answer 1

A. Liquidity ratios are involved with finding out the liquidity of the company in terms of ability of the company to repay all its fixed obligation in the short period of time so the company will be having enough current assets and cash in order to discharge its fixed repayment liability and if the company is having an excess of current asset then the company will be having a higher liquidity,so it will be reflecting the ability of company to discharge the debt obligation in short period of time.

B. Solvency risk is a risk associated with company going completely insolvent and it is related to to financial strength in the long run and it is representing the sustainability of the company and the solvency ratios will be reflecting the capital structure and survivalship of the company as when the company will be having a higher amount of debt capital and higher amount of redemption and the company does not have enough asset to cover all these liabilities then the company will be having a solvency risk because it will be having a risk associated with going insolvent.

C. profitability ratio will be reflecting the ability of the company in order to make higher profits and it will be reflecting profitability on the operating front and total net income front.

inventory is impacting the overall liquidity ratio of the company because it is impacting the current ratio as well as the quick ratio and it is also impact in the the turnover ratios .

Manager might make various changes in order to improve the financial ratios like we can improve the cash collection cycle to improve liquidity ratio or he can cut down the debt capital in order to improve the solvency ratio.