Question

Provide measurements indicators for profitability, solvency and liquidity as important financial analysis a business focused on.

Answer 1

Measurement indicators for Profitability, solvency and liquidity are the various ratios used to determine the business' health.

Profitability ratio is used to measure the company's ability to generate profit as compared to its various costs and expenses.
a) Gross profit margin: It is measured as the ratio of gross profit to the company's revenue. Higher gross profit margin means the company is pricing its product well and is able to cut down on its cost of good sold.
b) Operating profit margin: It is calculated as the operating profit of the company divided by its total sales. Operating margin measures the company's operating efficiency and also measures how much the company is left with after covering its cost of good and operating expenses.
c) Net profit margin: It is the total net profit the company earns as compared to its revenue. Higher net profit margin indicates the company has been able to cut down on its cost along with managing the interest and other expenses well.

Solvency ratio is used to measure the company's ability to meet its long term obligations. It is calculated as follows:
Solvency ratio = Net after tax income plus cash expenses divided by short term liabilities and long term liabilities.

Liquidity ratio measure the company's ability to meet its short term obligations
Current ratio : This is calculated as Total of current assets to current liabilities. Current ratio of 1 or greater is considered to be a good ratio indicating that the company has enough liquidity to meet is short term obligations.

Quick ratio : It is same as current ratio except that the company's inventory is not included. This is because inventory is sometimes considered to be ill-liquid at times and hence this is a tighter measure of a company's liquid profile.

Cash ratio: This is the most conservative form of measuring the liquid profile of a company. It is calculated as the total cash of the company to its current liabilities.


These are all an important indicators which all the businesses focus on to understand their health. These are also used to compare their performance with other companies in the industry. It helps them to focus on their weakness and thus is used to identify areas where they need more attention.