Profitability & Liquidity Summary

1 Found helpful • 6 Pages • Topic Notes • Year: Pre-2021

Analysing- examining the financial reports in detail to identify changes or differences in performance. Interpreting- examining the relationships between the items in the financial reports in order to explain the cause and effect of changes or differences in performance. Profitability - The ability of the business to earn profit, measured by comparing its profit against a base such as sales, assets or owner’s equity. A firm’s ability to earn profit is dependent on its ability to: - Earn revenue - Control expenses Consequently any analysis of profitability must examine the firm’s performance in these two areas, with analysis of the Profit and Loss Statement a logical starting point. The size of the business (in terms of the assets it controls), the size of the investment by the owner, and the level of sales are all significant in determining how much profit a business is able to earn. If the profit were expressed per dollar of assets, a comparison of the ability of each firm to earn profit if they had the same asset base would be possible, showing which was more profitable. Thus, profitability is more than assessing the firm’s profit; it is about assessing the firm’s capacity or ability to earn profit, assuming all these factors were equal.

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