Question

3. Imagine you are a supplier and ABC Company is asking you for 30 days credit on their purchases. What financial ratios (give at least two) would you use to make your decision? Explain why you chose each ratio.

Answer 1

As a supplier, one needs to check the Liquity ratios and the profitability ratio, and creditors turnover ratio.It is explained as under-

1) Liquidity measures how quickly a company can repay its debts. They also show how quickly and easily a company is in generating cash to repay creditors quickly, either in an emergency situation or in the course of normal business.

• Current ratio.The current ratio measures your company's ability to generate cash to meet your short-term financial commitments. it is calculated by dividing your current assets—such as cash, inventory and receivables—by your current liabilities, such as line of credit balance, payables.
• Quick ratio- The quick ratio measures your ability to access cash quickly to support immediate demands. The quick ratio measures your ability to access cash quickly to support immediate demands.

2) Profitability ratios are used to evaluate the financial viability of your business.

• Gross profit ratio - It measures the margin on sales the company is achieving. It can be an indication of manufacturing efficiency, or marketing effectiveness.It tells whether the firm is making enough revenue to cover the cost of good sold.
• Net profit ratio - It measures the overall profitability of the company, or how much is being brought to the bottom. This is very important ratio as no business can carry out its operations in long run if it doesnot have enough profits to cover the expenses. If the net profit ratio is not satisfactory there may be a chance the business will go out of business soon and is not able to pay off its debts.

3) Creditors turnover ratio or accounts payable turnover ratio - It is a ratio that measures the speed with which a company pays its suppliers. If the turnover ratio declines from one period to the next, this indicates that the company is paying its suppliers more slowly.

The rate at which a company pays its debts could provide an indication of the company's financial condition. A decreasing ratio could signal that a company is in financial distress.

Hope it helps!