Question

3.)

List at least 5 solvency ratios, 5 liquidity ratios, and 5 profitability ratios, showing the formula for each and a brief explanation of why they are useful.  

Answer 1

Liquidity ratios measure the company's ability to meet it's short term obligations.Higher the liquidity ratios higher the ability of the company to meet it's current liabilities.

Current ratio=Current Assets/Current liabilities

It's a measure to which the current assets cover the current liabilities.A higher ratio indicates greater ability to pay current liabilities with current assets and thus imply greater liquidity.

Quick ratio=Cash+marketable Securities +Accounts receivable/Current liabilities

Quick ratio serves as a strong indicator of short term solvency.The inventory isn't factored into quick ratio since it's turnover is at a slower rate.

Cash ratio=Cash +marketable securities /current liabilities

It analyses liquidity in a more conservative manner than quick ratio.A cash ratio that's too high indicates that a company is not using it's resources productively.

Cash flow Ratio=Operating Cash flow/current liabilities

Indicates the firm's ability to meet it's debt obligations with cash generated in normal course of business.A higher cash flow ratio shows a greater likelihood that a firm will be able to meet it's obligations with cash generated from normal business operations.

Net working Capital ratio=Current Assets-Current liabilities

This ratio is often expected to be positive ,as it's a key indicator of short term liquidity.

Solvency ratios

Times Interest Earned ratio=Earnings Before Interest and taxes/Interest expense

If the ratio is sufficiently high the firm should be able to meet it's interest obligations.

Debt to total Assets Ratio=Total debts /total assets

a lower debt to total assets ratio indicates a better position for creditors ,because the company has enough assets to cover long term debt obligations.

Debt to equity ratios=Total debt/Equity

A higher ratio indicates that the firm is highly leveraged and there is a higher risk of bankruptcy.

Long term debt to equity ratios=Total debt-Current liabilities/Equity

A company with a low long term debt to equity ratio has the ability to raise debt capital if it is needed.

Financial leverage Ratio=Assets /Equity

a financial leverage ratio of 2.0 reflects that the liabilities of the company are equal to the equity.A ratio of greater than 2.0 implies that liabilities are larger than equity, and less than 2.0 implies higher equity than the liabilities of the company.

Profitability Ratios

Gross profit margin percentage=Gross Profit/Sales

the trend of the Gross profit margin percentage as to it's rise fall and it remaining steady indicates the the firm's ability to manage it's cost of sales.

Operating Profit margin=Operating Income/sales

It's movement with changes in gross margin helps analysts make a judgement about the absolute amount spent on the additional expenses..

Net profit margin=Net income/Sales

The net profit margin might diverge from operating margin and the most common reason for this is a rise in tax and interest rates.

Return on Investment=Income of business Unit/assets of business unit

Greater ROI means a greater return on investment.ROI i a popular measures of profitability because it combines revenues ,investments and costs all in one figure.

Return on Assets=Net Income/Average Total Assets

ROA is frequently used to measure the success of the firm.Higher ROA means greater the success the firm had on making it's total assets productive.