Profitability and Financial Ratios for Company Analysis and Project Financing

Finance

Answer a).
Profitability ratios interpret and compare income statement to show whether a
company is able to generate the profits from the operations. These ratios focus on return on
investment made by shareholders. Profitability ratios show how efficiently the company
achieves profits from operations. These ratios are used to assess the ability of business to
generate revenue and profits in relation to associated expenses. Higher ratio as compared to
its competitor`s ratio or previous year indicates that organisation is performing well (Mousa,
2015). Under the profitability ratio, a company uses certain ratios, which are discussed
under:-
Gross profit margin- This margin measures where a company mark up COGS above its sales.
This ratio compares gross margin of an organisation to its net sales. Gross profit ratio looks at
COGS as a percentage of net sales. This ratio evaluates at how well companies control the
cost of inventory and manufacturing of product and consequently pass the cost to customers.
Investors use gross profit ratio to calculate the percentage to compare a company in which
they want to invest to the other similar companies (Mousa, 2015). This ratio tells investors
that whether the gross profit margin of target company is sound or not.
Operating margin- This ratio measure and evaluation of overall operational efficiency,
incorporating ordinary expenses and daily business activity. Operating margin refers to the
percentage of sales, which is left after including all the additional operating expense. This
ratio is used to determine the efficiency of the management of the company by analysing

operating expenses to net sales. This ratio uses operating profit or income which is total pre-
tax income generated from operations (Mousa, 2015).
Return on assets- Profitability is analysed in relation to assets to look whether the company is
deploying its assets to generate revenue and profits. Return in this ratio refers to net income
or profits which is generated from sales after the costs, taxes and expenses (Willy, 2016).
From the point of investors, asset turnover ratio reveals to investor the lump sum amount of
sales for $1 of assets. This tells the investor that how much profit an organisation generate for
each $1 in assets. Return on assets is always a good way to measure the intensity of assets of
the business (Uechi, Akutsu, Stanley, Marcus, & Kenett, 2015).
Answer b).
Financial ratios are used to measure the company’s capital structure and its risk level as being
assessed in context to company`s debt level. It is an ability of the company to accomplish
outstanding debt which is absolutely critical to company`s financial soundness and its
operating ability. Certain financial ratios used by the investors to assess the organisation`s
financial risk and overall financial health that comprises of Debt-equity ratio, interest
coverage ratio, and debt-capital ratio (Mitrovic, Knezevic, & Velickovic, 2015). Investors
and the analysts use these ratios to measure the level of financial risk. Solvency ratios are
used to measure ability of the company to meet the long-term obligations. In general, it
measures the size of the company`s operations in relation to their obligations. By analysing
the solvency ratio, an investor can get insight in how a company is likely continue to meet the
debt obligations. Higher is the ratio, stronger is the financial strength. Lower ratio, on the
other hand, indicates that company has financial struggles in future (Willy, 2016).