identify three aspects of a company's financial health that stakeholders are interested in. Describe a financial ratio that is useful in measuring each aspect.
Three aspects of a company's financial health that stakeholders are interested in are profitability, liquidity, and solvency. Stakeholders include investors, creditors, employees, and even customers who can be affected by the financial position of the company.
1. Profitability:
Profitability ratios measure the ability of a company to generate profits from its operations. One commonly used ratio to measure profitability is the Return on Investment (ROI) ratio. ROI indicates how effectively a company utilizes its resources to generate profits. It is calculated by dividing the company's net income by its total assets, and multiplying the result by 100 to express it as a percentage.
2. Liquidity:
Liquidity ratios assess a company's ability to meet its short-term obligations. One widely used liquidity ratio is the Current Ratio. It determines a company's ability to pay off its short-term liabilities with its short-term assets. The formula is to divide current assets by current liabilities. A ratio higher than 1 indicates that the company has sufficient short-term assets to cover its liabilities.
3. Solvency:
Solvency ratios measure the long-term financial health of a company by evaluating its ability to cover its long-term debts. One common solvency ratio is the Debt-to-Equity (D/E) ratio. The D/E ratio compares a company's total debt to its total equity. It is calculated by dividing total debt by total equity. A lower D/E ratio indicates that the company has less debt relative to its equity, which implies a higher level of solvency.
To analyze a company's financial health, stakeholders can calculate these ratios using the company's financial statements, such as the balance sheet and income statement. These statements provide necessary information about a company's assets, liabilities, income, and expenses.