Question

30. What is a ratio that measure's a company's profitability: 31. What is a ratio that measure's a company's solvency?

Answer 1

Q30. What is a ratio that measures a company profitability?

Answer:

Introduction:

As the name suggests profitability ratio measures the profit business is generating. It assess the business ability to create earnings.

Higher value of these ratio shows better business performance.

Common Profitability ratio are:

a) Gross Profit Margin:

It shows the gross profit as a percentage of sales

It is calculated by using the following formula:

Gross Profit Margin = (Gross Profit / Sales) * 100

b) Operating Profit Margin

It shows the operating profit as a percentage of sales

It is calculated by using the following formula:

Operating Profit Margin = (Operating Profit / Sales) * 100

Operating Profit = Earnings Before Interest & Tax (EBIT) = Sales – Cost of Goods Sold – Operating Expenses.

c) Net Profit Margin

Net Profit Margin = (Net Income / Sales)* 100

31. What is a ratio that measures a company solvency?

Answer:

Introduction:

The firm’s ability to meet its long-term obligations is calculated by using Solvency Ratio. In simple words we can say that Solvency Ratio financial health of a company and the sustainability of the company in the long run.

Common Solvency Ratio that can be used to identify resources required by an organisation to meet Long-term obligations are:

a) Debt- Equity Ratio (Sometimes called as Balance Sheet ratio):

This ratio shows the amount of total debt in comparison to equity. This is calculated by dividing the business’s total liabilities shareholders’ equity.

It is calculated by using the following formula:

Debt- Equity Ratio = Total Liability (Long term + short term) / shareholder’s equity

The maximum Debt Equity ratio should be 2:1.

b) Interest coverage ratio:

Generally, all the debts carry interest cost. This ratio shows that whether the firm is able to pay the interest on its long-term debt by its net profit before interest and tax.

It is calculated by using the following formula:

Interest coverage ratio: Net profit before interest and tax / Interest on Long term debt

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