Liquidity ratios

Liquidity Ratios

Liquidity ratios reflect a company’s ability to meet its current liabilities when they become due. They also demonstrate a company’s ability to generate consistent cash flows in order to pay its operating obligations. The key liquidity indicators are the current and quick ratios (“Liquidity Ratios | Example | My Accounting Course,” 2017). The current ratio, calculated as current assets divided by current liabilities, demonstrates a company’s capacity to pay off its short-term obligations using its current assets (Kirkham, 2012). Starbucks’ current ratio was 1.04 in 2016 (“Growth, Profitability, and Financial Ratios for Starbucks Inc (SBUX) from Morningstar.com,” 2017) and this indicates that the current assets are sufficient to meet the short-term obligations.

On the other hand, the quick ratio

is stricter than the current ratio, and it shows the ability to pay off the current liabilities using its quick assets. Quick assets are those assets which can be comfortably converted into cash within 90 days, and they are accounts receivable, cash and cash equivalents, and short-term investments. Starbucks quick ratio is 0.67, showing that there are insufficient liquid assets to pay off its current liabilities. A ratio less than 1 is unfavorable, and it might be an indicator that the company might face liquidity problems in the future.

Profitability ratios

These ratios show the ability of a company to generate profits from its operational activities. They are of critical interest to creditors and investors because they judge the performance of a company based on the profits it makes. The most important profitability ratios are the net profit margin and the return on equity. The profit gives the net profit margin after tax divided by sales, and it shows the amount of net income generated from each dollar of sales. A high net profit margin is preferred by investors because it might indicate that the company has the income to distribute its dividends while creditors get the assurance that their loans will be repaid. For the year ended 2016, the net profit margin was 13.22% meaning that it generates $0.1322 in income for every dollar of sales.

The return on equity calculated by net income divided by shareholders equity shows the ability of a company to generate profits from the shareholder’s funds. ROE indicates some earnings in income generated from every dollar of stockholder’s equity in the firm. The ROE for Starbucks was 48.16% meaning that every dollar of shareholder’s equity generated $0.4816 for every dollar of sales. The ratio is of great significance to investors (potential) because it tells them how efficiently the management is utilizing the equity funds to generate income.

Solvency ratios

Solvency, or leverage ratios, are a measure of the ability of a firm to continue its operations in the long term by showing the capacity to pay its long-term commitment. They indicate the ability of a company to pay its long-term commitments to banks, creditors, bondholders and they are of interest to these parties because they reveal the financial soundness and going concern ability. The most significant solvency ratio is the debt ratio. The debt ratio is given by total liabilities divided by total assets, and it reveals the percentage of assets financed by borrowed funds. Therefore, a lower debt ratio is preferable because it shows that borrowers have a little stake in the assets of the company and the going concern is not under threat. Starbucks’ debt ratio is 2.44 (“Growth, Profitability, and Financial Ratios for Starbucks Corp (SBUX) from Morningstar.com,” 2017), showing that borrowed funds finance the assets 2.44 times and this is an indicator that the going concern ability is under threat.

Ratios affected by inventory

Ratios affected by inventory are a quick ratio, inventory turnover, and current ratio. Inventory turnover is given by cost of sales divided by average inventory and its shows the efficiency of inventory management. An increase in the inventory increases the current ratio, but in the quick ratio, inventory is not considered liquid assets because it cannot ultimately sell off within the next ninety days. Improving most of the ratios for Starbucks Company such as the profitability ratios requires an increase in sales or reducing expenses while improving the solvency ratio requires greater control and efficiency over debt.

References

Growth, Profitability, and Financial Ratios for Starbucks Corp (SBUX) from Morningstar.com. (2017). Financials.morningstar.com. Retrieved 4 May 2017, from http://financials.morningstar.com/ratios/r.html?t=SBUX

Growth, Profitability, and Financial Ratios for Starbucks Corp (SBUX) from Morningstar.com. (2017). Financials.morningstar.com. Retrieved 4 May 2017, from http://financials.morningstar.com/ratios/r.html?t=SBUX

Kirkham, R. (2012). Liquidity analysis using cash flow ratios and traditional ratios: The telecommunications sector in Australia. The Journal of New Business Ideas & Trends, 10(1), 1

Liquidity Ratios | Example | My Accounting Course. (2017). My Accounting Course. Retrieved 4 May 2017, from http://www.myaccountingcourse.com/financial-ratios/liquidity-ratios