Discuss Measures of Liquidity, Profitability, and Solvency.
A presidential election year is on the horizon. Control of the White House may shift political parties. Whenever there is potential for a shift in political parties, defense spending could end up being reduced. You are presently a support analyst for a financial fund administrator with an extensive amount of money invested in the Boeing Corporation, a publicly traded company. Part of Boeing’s operations are in defense contracting, such as the manufacturing of military aircraft and helicopters. You must evaluate the current stability of Boeing to determine whether to recommend moving money from this investment to another investment.
Instructions
Write a management report to your fund administrator that:
Explains the different liquidity, profitability, and solvency ratios that are used to assess the financial health of a corporation.
Computes the liquidity, profitability, and solvency ratios using the 2018 Boeing Corporation’s financial statements.
Computes the liquidity, profitability, and solvency ratios of Airbus, a passenger plane competitor, using the 2018 financial statements.
Compares and contrasts the financial ratios of Boeing and Airbus.
Provides a recommendation, supported by the ratio calculations, as to whether you believe Boeing is stable enough compared to the competitor that if defense funding is reduced, the company will continue to prosper.
Solved by verified expertLiquidity measures: Liquidity measures indicate a company’s ability to meet its short-term obligations, such as paying bills and meeting payroll. Some common liquidity measures include:
Current ratio: This measure compares a company’s current assets to its current liabilities. A current ratio of 1 or higher indicates that a company has enough current assets to cover its current liabilities.
Quick ratio: Also known as the acid-test ratio, this measure is similar to the current ratio, but it excludes inventory from current assets. This measure provides a more conservative estimate of a company’s ability to meet its short-term obligations.
Cash ratio: This measure indicates the amount of cash and cash equivalents a company has on hand relative to
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Profitability measures: Profitability measures indicate a company’s ability to generate profit from its operations. Some common profitability measures include:
Gross profit margin: This measure indicates the percentage of revenue that remains after deducting the cost of goods sold. A higher gross profit margin indicates that a company is generating more profit per dollar of revenue.
Net profit margin: This measure indicates the percentage of revenue that remains after deducting all expenses, including taxes and interest. A higher net profit margin indicates that a company is generating more profit per dollar of revenue.
Return on equity (ROE): This measure indicates the amount of profit a company generates relative to the amount of shareholder equity invested. A higher ROE indicates that a company is generating more profit from shareholder equity.
Solvency measures: Solvency measures indicate a company’s ability to meet its long-term obligations, such as paying off debt. Some common solvency measures include:
Debt-to-equity ratio: This measure compares a company’s total debt to its shareholder equity. A higher debt-to-equity ratio indicates that a company has more debt relative to its equity, which may indicate higher financial risk.
Interest coverage ratio: This measure indicates a company’s ability to pay its interest expenses on its debt. A higher interest coverage ratio indicates that a company is generating enough operating income to cover its interest expenses.
Debt-to-assets ratio: This measure compares a company’s total debt to its total assets. A higher debt-to-assets ratio indicates that a company has a higher amount of debt relative to its assets, which may indicate higher financial risk.
In summary, liquidity measures help assess a company’s ability to meet short-term obligations, profitability measures help assess a company’s ability to generate profit from its operations, and solvency measures help assess a company’s ability to meet long-term obligations. Together, these measures provide a comprehensive picture of a company’s financial health and performance.
