Accounting – 6.3 Inter-firm comparison | e-Consult
6.3 Inter-firm comparison (1 questions)
Comparison of ABC Ltd and XYZ Co. using Financial Ratios
To compare the financial performance of ABC Ltd and XYZ Co., we can analyze several key financial ratios. These ratios provide insights into liquidity, profitability, and solvency. Here's a breakdown:
Liquidity: The current ratio measures a company's ability to pay its short-term liabilities with its short-term assets. ABC Ltd has a current ratio of 2.5, while XYZ Co has a current ratio of 1.8. A higher current ratio generally indicates better liquidity. Therefore, ABC Ltd appears to be more liquid than XYZ Co.
Profitability: The profit margin indicates how much profit a company makes for every £1 of revenue. ABC Ltd has a profit margin of 8%, while XYZ Co has a profit margin of 6%. A higher profit margin is generally desirable. ABC Ltd's higher profit margin suggests it is more efficient at converting revenue into profit.
Solvency: The debt-to-equity ratio measures the proportion of debt and equity used to finance a company's assets. ABC Ltd has a debt-to-equity ratio of 0.8, while XYZ Co has a debt-to-equity ratio of 1.2. A lower debt-to-equity ratio generally indicates a stronger financial position. ABC Ltd has less debt relative to equity, making it less risky.
Conclusion: Based on the analysis of these ratios, ABC Ltd appears to be in a stronger financial position than XYZ Co. It has better liquidity, higher profitability, and a lower level of financial risk (solvency). While XYZ Co has a higher profit margin, its lower liquidity and higher debt levels are concerning. Therefore, ABC Ltd is the more financially sound company.