Profitability refers to the increase in stockholders' equity resulting from revenue exceeding expenses. Measures of profitability, such as net income, give insights into how well a company is generating profits. Financial statements, particularly the income statement, are vital for assessing profitability. Specific measures include:
Net income as a percentage of sales (management's ability to control expenses).
Return on assets (measuring how effectively a company uses its assets to generate earnings).
Liquidity refers to a company's ability to meet its cash obligations as they become due. Unlike profitability, liquidity focuses on the company's short-term financial health. Even a profitable company can face liquidity issues. Financial statements, especially the balance sheet, are crucial for assessing liquidity. Common measures include:
Current ratio (current assets divided by current liabilities).
Quick ratio (quick assets divided by current liabilities).
These tools allow analysts and investors to evaluate both short-term cash flow management and long-term profitability.