Profitability is a measure of the efficiency of a business to use its resources. It is measured by the return on the capital resources it uses which means the combination of debt and equity. This is given by the ratio return on capital employed (ROCE), return on investment or accounting rate of return. This tells investors how successful the business is by analyzing the profitability. The higher ROCE, the more liable it is to carry a high return to the investors resulting in higher dividends and rising share prices. The profitability is important for businesses which want to attract financial funds. A business with high profitability means the business has the ability to earn profit. It is commonly say that a business needs funds to support its capital or running cost. For a high profitability business, funds can be easier to collect since the shareholders will expect that such business is profitable. Thus the business can state in a health financial position. In addition, profitability is different from profit. Profitability is a relative term but profit is an absolute term without any comparison. A company may gain a high return in a business, but profit of such business made does not reflect the relative input. Maybe the capital is very high or the resource for the business is rarely to find or extract that reducing the willingness of the shareholders to support the business. The following ratio is common use in measuring profitability 1. ROCE = Profit before interest and taxation/Capital employed x 100% 2. Asset turnover = Sales/Capital employed x 100%
3. Profit margin = Profit/Sales x 100%
Liquidity is the measures of a company’s ability to pay its debts to continue trading. If it cannot cover its short-term liabilities from its current assets, the company should terminate their business and need to go into liquidation. The liquidation is measures by the following ratio
1. Current ratio = Current assets: Current liabilities
In ideal case, it should...
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