Good Example Of Financial Case Study Critical Thinking

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Part 3

Liquidity Ratio
Leverage (Debt) Ratios
Profitability (Performance) Ratios
Activity Ratios
Liquidity
Liquidity is the ability of a firm to repay its short-term obligations when they become due. Short-term obligations can only be repaid using the firm’s current assets. Therefore, a firm is said to be liquid when the current assets are more than the current liabilities. The current ratio for the company was 93.75% in 2014 and 79.87% in 2013. This implies that P&G’s current assets were not sufficient to meet its short-term debts. The increase in the current ratio indicates that the liquidity P&G increased in 2014. An increase in liquidity will have a positive effect on the short-term performance, which will in turn influence the long-term performance.

Profit margin

A Profit margin is the amount of net income P&G earns from every dollar of total revenue. A high-profit margin implies the company is profitable either through cost controls and higher sales or both. The profit margin for 2014 was 14.19% implying that P&G earned a profit of $0.1419 for every dollar of revenue. The ratio increased from 13.81% in 2013 indicating that the profitability of P&G improved. The increase will positively impact both the short-term and long-term performance by increasing liquidity, solvency and returns to shareholders.

Debt-equity ratio

The debt-equity ratio is the amount of total debt for every dollar of total equity. The ratio measures the solvency of the company. A high debt-equity ratio indicates that the company is less solvent. The debt-equity ratio for P&G increased from 102.27% in 2013 to 106.16% in 2014. This indicates that the company’s leverage increased. Hence, its solvency declined. The decline in solvency increases the financial risk that may negatively affect the long-term performance of the firm. However, if P&G is efficiently using its debt, an increase in leverage will result in an increase in return on equity provided the return on assets is positive. This will have a positive effect on the short-term and long-term performance.

How inventory and Inventory turnover affect liquidity

A large balance of inventory reduces liquidity since inventory ties up funds thereby crowding out funds for other operating activities. A business with a higher inventory turnover will have a greater liquidity than one with a lower inventory turnover.

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