Question

Suppose a firm is losing money. What ratios would you look at in order to determine the cause of the problem?

Answer 1

Answer-

The firm should consider the Liquidity and Profitability ratios to determine the cause of the problem.

The liquidity ratios are
Current ratio = Current assets / Current liabilities
Quick ratio = ( Current assets - Inventory ) / Current liabilities
Cash ratio = ( Cash + Cash equivalents ) / Current liabilities

The Probitability ratios are
Net profit margin = Net profit / Sales
Gross profit margin = Gross profit / Sales
Operating profit margin = EBIT / Sales
Return on Assets = Net income / Assets
Return on Equity = Net income / Equity

The above Liquidity ratios help determine the company's financial health in meeting short term obligations ( Liquidity ratios) and identify where the company is losing money by comparing the ratios for 3-5 years period. it will help us determine whether the company is facing cash crunch and how the inventorty and account receivables are adequate. It helps us determine whether the accounts payable and short term debt are high and current payment of long term debt is causing the company to loose money.

The Profitability ratios help in determining how profitable the company is and helps in determining whether the company is paying more SG&A expenses and what is its interest expense and taxes post EBIT and how the EBIT margin and Net profit margin are fluctuating over some recent years. The ROA and ROE will help us how efficiently company is using assets and equity in generating profit or net income.