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Review Questions

Review Questions

1. The simplest way to explain liquidity ratio is to do so through the proportion of liquidity reserve to the total amount of the company’s assets or, in other words, the ability of a company to pay off its obligations. The current ratio, the quick ratio, and the operating cash flow ratio are the key elements of this proportion. Calculation of either current assets (with or without inventories) or available means from the transactions are divided by current liabilities. In general, the liquidity ratio shows the company’s financial health. The work of this ratio may be perfectly observed by using the example of two Global Consumer Electronics companies: Apple and Sony. Quick ratio of Apple is 1.06 (“Apple Inc”), which generally indicates good short term financial strength, as it is higher than 1, and, besides, its 10-year quick ratio range varied from 3.38 as maximum and 1.05 as minimum (“Apple Inc”). While Sony’s current ratio is 0.87 (“Sony Corop”), which demonstrates that the company may face some difficulties with meeting its current obligations. However, this company has good long-term perspectives, so it may borrow money to cover current obligations. As a conclusion, the higher the liquidity ratio is, the more likely the company is going to cover its debts.

In my opinion, the profitability ratio shall be defined through the proportion of proceeds to expenditures that are taken for the specific period of time. In general, it helps to find out whether it is worth investing in the exact companies by learning such their profitability ratios as GPM, NPM, ROE, ROA, and ROI. Taking the example of Return on Equity ratio, which indicates the amount of profit generated for the company by the money invested into it by stakeholders, of Apple and Sony shows that Apple has increased its ROE almost by 10% from 31.21%  to 41.55% (“Apple Inc”) within a year. Sony has also improved its ROE by 1% from -4.49% to -3.60% (“Sony Corop”); however, it is still negative. To sum it up, a declining liquidity ratio should be a warning sign to investors while the increasing profitability ratio points out that investors receive benefits from venturing in the exact company.

2. The Square company once said “The growth of our business depends in part on existing sellers expanding their use of our products and services” (Aspan). This is the first and the perfect argument, why equity capital is better than debt. Equity investors search for the long-term perspective and they may give great many contacts and pieces of advice. Meanwhile, banks as any other institutions that give loans and then look forward to monthly or annual repayment, will never give the company any impetus to expand and develop, as they only seek security. Furthermore, they may consider it so risky, that security deposit and interest costs will be huge, and the owner of the company will be required to personally guarantee repayment of the loan. It seems as too many obstacles on the way to extending the company in the era of capitalism.

While on the other hand there are some drawbacks of the equity capital as well. Not to pay back anything, the owner of the company has to share the percentage of the company with the investor and to take decisions in consultation with him/her. As a result, the loss of control of the business is feasible. However, the example of the world’s most prosperous company of Facebook shows that the stock split does not impede the growth and development. What is more, the existence of not simply common stocks, but also preferred stocks gives chance to the companies’ owners to have investors who do not have any vote, but receive preferences in dividends.

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