Question

Ricardo Rocks (RR) is a public listed manufacturing company and we can calculate financial ratios from its financial statements.

What financial ratio(s) would you analyze and why, if you are:

1. A supplier that requires payment of amount due in 2 weeks and looking to extend

   credits to RR

2. A new investor interested to invest in RR

3. A banker looking to extend a long-term loan to finance RR for a new investment

   project

Please explain in your own words.

Answer 1

Solution 1) For a supplier who is considering to extend the credit period will look into the liquidity ratios of the firm. Liquidity ratios are used to measure the ability of the firm to pay off its short-term liabilities and debt obligations due in one year. A supplier would be interested to know that will the company be able to pay off its liabilities or not. If the company ahs higher liquidity then the supplier would be comfortable in extending the credit.

Liquidity ratios include:

A) Current Ratio = Current Assets/Current Liabilities

B) Quick Ratio = (Current Assets - Inventories)/Current Liabilities

C) Cash Ratio = (Cash + Marketable Securities)/Current Liabilities

Solution 2) For an investor who is looking to invest will be more focused on the profitability ratios. These ratios will measure the company's ability to generate profits. Few profitability ratios include:

A) Return on Equity (ROE) = Net Income/Shareholder's Equity

B) Return on Assets (ROA) = Net Income/Total Assets

C) Net Profit Margin = Net Income/Total revenue

D) Gross Profit Margin = Gross Profit/Total revenue

E) EBIT Margin = EBIT/Total revenue

Solution 3) As a lender and provider of debt, the bank would be focused on measuring the company's ability to repay the debt. This includes analyzing the Solvency ratios. Common solvency ratios that can be used are:

A) Debt Equity Ratio = Total debt/Total equity

B) Debt ratio = Total Ratio/Total Capital

C) Interest Coverage Ratio = Net Profit before Interest and TaxInterest on Long-Term Debt

Please comment in case of any doubts or clarifications required. PLease Thumbs Up!!