The three categories of ratios used by financial analysts in evaluating the financial performance are profitability, liquidity, and solvency Weygandt, Kimmel, & Kieso, 2017. Profitability refers to the ability of a company to produce revenue greater than expenses in the normal course of business (i.e. make a profit); the ratios for profitability are earnings per share (EPS), price-earnings ratio, gross profit rate, profit margin, return on assets, asset turnover, payout ratio, and return on common stockholder’s equity (Weygandt et al, 2017). Liquidity of a company refers to the amount of cash on hand or cash equivalents readily convertible to cash that are able to be used to cover cash outflows such as payroll. The ratios in determining liquidity are working capital, current ratio, inventory turnover, days in inventory, accounts receivable turnover, average collection period (Weygandt et al, 2017). Solvency is the ability of a company to continue over a long period of time and pay debts as they come due. The ratios for solvency are debt to asset ratio, times interest earned, and free cash flow (Weygandt et al, 2017). Each category has one particular ratio that most clearly demonstrates the financial abilities of a company. In terms of profitability the profit margin ratio is the most indicative of future performance; for the company I have chosen, Dick’s Sporting Goods, their profit margin is a mere 3.8%. However, even though the profit margin is small, it is still a profit and therefore is sustainable. As for solvency, which also measures if a company will be able to continue operations, the most important ratio is free cash flow. For Dick’s Sporting Goods, their free cash flow was $425,263 (in thousands) for 10-K filed in 2019. This indicates that cash available for operations was $425,263 (in thousands) to be used for dividends, reinvestment, stock buyback, and minimizing the need for additional loans. Finally, the most important ratio for determining liquidity of a company is working capital. For Dick’s, the working capital was $617,759 (in thousands) meaning the company has a significant ability to pay its obligations as they come due and in the even of an unexpected circumstance to continue operations without taking on additional debt.
Profitability ratios measure the overall performance of a company and its efficiency in managing assets, liabilities, and shareholders’ equity. It shows the company’s ability to generate profitable sales from its resources. Profitability ratios include gross profit margin, operating profit margin, net profit margin, return on assets (ROA), and return on equity (ROE). The profitability ratio I believe to be most indicative of future performance is net profit margin ratio, since it measures profitability after consideration of all revenue and expenses, including interest and taxes. Berkshire Hathaway has a net profit margin of 18.61%. This ratio shows that Berkshire Hathaway is a strong indicator of the company’s profitability and overall success
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