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Produce a report evaluating the relative significance of solvency and profitability ratios in identifying serious problems of business performance.

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Introduction

Transfer-Encoding: chunked I?m going to produce a report evaluating the relative significance of solvency and profitability ratios in identifying serious problems of business performance. Ratio analysis is the single most important technique of financial analysis in which quantities are converted into ratios for meaningful comparisons, with past ratios and ratios of other firms in the same or different industries. Ratio analysis determines trends and exposes strengths or weaknesses of a firm. I agree that solvency and profitability ratios can be used to identify serious problems in a business?s financial performance. However, businesses must be aware that profitability and solvency ratios should be used with caution as these ratios have limitations. For instance, solvency and profitability ratios alone won?t tell you the full story of the business?s performance. Therefore, the business should be aware that there may be other factors internally and externally which could contribute to the business performing poorly. There are many reasons why the use of ratio analysis will benefit a business. Firstly ratio analysis simplifies the financial statements and helps in comparing companies of different size with each other. This can be beneficial to a business because they can gain ideas for their own business to help improve their performance. ...read more.

Middle

If the current ratio is less than 1 then they are in trouble and means the business has more liabilities than current assets. Furthermore, if the acid test ratio is closer to 0 it means the business is not in a position to pay their debts without selling their stock. These ratios can clearly show the business if they can pay their debts with or without selling their stock and can plan a solution if they can?t. The second ratio is profitability. These ratios assess the amount of gross or net profit made by the business in relation to the business?s turnover or the assets or capital available; this will be good for a business to use as they can see how much money they are making, and can see if there are any causes for concerns. An advantage of the profitability ratios is that they are simple to calculate and understand. This therefore means it?s very easy for the business to assess their ability to generate earnings compared to its expenses and other relevant costs incurred during a specific period of time. A disadvantage is once again, from this ratio you cannot see what factors are effecting the ratio. ...read more.

Conclusion

If they are inexperience they won?t be able to drive the company forward and motivate the staff therefore the business won?t perform efficiently. Another internal factor is the product life cycle. All products have a life cycle and they will start to decline. Therefore it?s important for the business to consider the product life cycle and what stage it is in. This is because they may need to rebrand or remodel the product. Lastly, a factor that can impact the business performance is if machinery breaks down. This is because the business will need machinery to manufacture their products and if it?s broken they won?t be able to. This will mean they have no products to sell which will lead them to poor sales and losses. In addition, if their machinery is broken they will need to repair or replace it which will cost money. This will have a negative effect on their ratios as they will have an increase in costs. In conclusion, I agree that solvency and profitability ratios are helpful to businesses. This is because they can highlight any problems that the business may be facing; such as being unable to settle their short term debts or if they are not making a significant profit. Although these ratios are very helpful, businesses need to be aware of other factors such as the economy, competitors, life cycle and loss of key staff. ...read more.

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