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# Calculating the profitability and liquidity ratios of two companies

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Taking the example of financial statements of any existing company for any two years, perform a ratio analysis using profitability ratios and liquidity ratios. After the calculations of the ratios analyse and comment on your findings of ratios about the profitability and liquidity position of that company. Identify the problem areas and give your suggestions.

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Profitability ratios, which are divided into two types, margins and returns, show a company's overall efficiency and performance with margin ratios representing the company's ability to convert sales dollars into profits and return ratios representing the company's ability to measure their overall efficiency in generating returns. Liquidity ratios attempt to measure a company's ability to pay off its short-term debt obligations by comparing a company's most liquid assets (Or, those that can be easily converted to cash), to its short-term liabilities.

Ratio analysis of Johnson & Johnson for 2011 and 2012
(Dollars in millions).

Profitability ratios
Gross profit margin - This ratio looks at a company's cost of goods sold as a percentage of sales and how well they control their costs of inventory and the manufacturing of its products. The higher the gross profit margin, the better it is for the company. This ratio is calculated by dividing gross profit by net sales with both figures being found in the company's income statement (Consolidated statement of earnings). The gross profit margin for Johnson & Johnson would be calculated as follows:

2011 - \$44,670 ÷ \$65,030 = 68.7%
2012 - \$45,566 ÷ \$67,224 = 67.8%

Operating profit margin - This ratio looks at a company's earnings before income tax (EBIT) as a percentage of sales which measures overall operating efficiency. A high operating profit margin means that the company has good cost control and/or that sales are increasing faster than costs, which is the optimal situation for the company. This ratio is calculated by dividing EBIT by net sales with both figures being found in the company's income statement. The operating profit margin for Johnson & Johnson would be calculated as follows:

2011 - \$12,361 ÷ \$65,030 = 19%
2012 - \$13,775 ÷ \$67,224 = 20.5%

Net profit margin - This ratio ...

#### Solution Summary

The solution assists with calculating the profitability and liquidity ratios of companies.

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