1) Identify and describe one of the financial measures of profitability, liquidity, efficiency, and leverage.
2) How can an analyst use one of these financial measures to evaluate the financial condition of a corporation?
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Financial measures of profitability, liquidity, efficiency, and leverage.
There are several financial measures that determine organizational performance. Some of the these measures include profitability, liquidity, efficiency, and leverage ratios (CFI, n.d). First, profitability measures include the net profit margin. It is derived from net profit divided by net sales. It assists in showing the firm’s ability to lower impacts of costs. Second, liquidity measures include the current ratio, quotient between current assets and current liabilities (CFI, n.d). It determines an organization’s ability to pay current liabilities.
Third, the efficiency ratios include the asset turnover ratio. It results from net sales and average total assets (CFI, n.d). The management uses it in determining the ability to generate sales. Fourth, we have the financial leverage ratios, concerned with debt management. One of the ratios is the debt ratio, total liabilities divided by total assets (CFI, n.d). The value has to be less than one, to ensure low proportion of assets sourced from debts.
Application of financial measures to evaluate the financial condition of a corporation
The study will consider the application of liquidity ratio and chose the current ratio. Therefore, the ratio will show whether the corporation pays its short-term obligations, void of any financial constraints (CFI, n.d). The obligations are those due within one year and have to be paid using the available assets. The inability to pay the suppliers implies that the corporation is experiencing financial challenges. The higher the current ratio, the more the ability to maximize current assets. A corporation with a higher ratio than its competitors has a competitive advantage over them (CFI, n.d). It should strive to maintain the position by avoiding excessive inventories.
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Financial ratios provide the economic status of any company. For any publicly listed company, the company must file quarterly reports and annual reports to the Securities and Exchange Commission. The securities and exchange commission regulate the financial data and makes sure that companies are listing out all the relevant data to the public and shareholders. The shareholders own a share of the company and have the right to know the financial condition of the company. The four major categories of the financial ratios are profitability, liquidity, efficiency and leverage. Liquidity is the company’s ability to pay off any short debts, and solvency is the ability to pay off long term debts (Carlson, 2019). Liquidity ratios can be calculated by using the information given on balance sheets (Carlson, 2019). Common liquidity ratios are cash ratio, current ratio and quick ratio. In quick ratio, the inventory cost is subtracted from assets, which gives a more precise idea than the current ratio (Carlson, 2019). The cash ratio only takes into account the cash equivalents, which can be converted to cash easily. Cash equivalents include market securities, money orders or money in the checking account. The leverage ratios are debt ratios which focuses on the company’s ability to pay the long term debt obligations (Carlson, 2019). Payable bonds, long term loans and pension funds are types of long term liabilities that are taken into consideration for leverage ratios. Types of leverage ratios are debt to equity ratio and debt ratio. Debt to equity ratios refer to the amount of money and retained earnings invested in the company (Carlson, 2019). Profitability ratios are used to measure the profit of the company. The net profit ratio and the contribution margin ratio are types of profitability ratios. The net profit ratio is the profit after tax divided by the net sales. The contribution margin ratio measures the profit made by selling each product after taking into account variable expenses (Carlson, 2019).
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