Assignment: Understanding the Concepts - Essay Example

Solvency ratios help small business owners to determine ability of their business to pay long term liabilities (New South Wales Government, 2012). Debt ratios help compare the total liabilities to the total assets. Debt Ratio= Total Liabilities ? Total Assets For example if total liabilities=$150, 000, while total assets=$300,000 Therefore, Debt ratio=150,000? $300,000= 0.5 On the other hand, profitability ratios help small business owners to determine ability of their business to generate earnings based on the expenses incurred (New South Wales Government, 2012).

Some of the profitability ratios include; Net profit margin and return on assets. Net profit margin may be determined as follows. Net Profit Margin= Earnings before income and tax (EBIT) ? Sales while on the other hand, Return On Assets= Earnings before income and tax EBIT) ? Total Assets. For example if EBIT=$800,000, Sales=$1,000,000 while total assets=$300,000 Return on Assets=800,000?$1,000,000=0.8 Return On Assets=$800,000?$300,000=2.6666 Connectively, liquidity ratios are important tools used by small business owners to determine the ability of their business to pay the outstanding debts (Charantimath, 2006). . Current Liabilities Current Ratio=$750,000?

$350,000=2.1429 Inventory Turn over Ratio= Cost of goods sold (C.O.S) ? Inventories in the Current period Inventory Turn over Ratio=$600,000?$240,000=2.5 Receivable Turnover Ratio = Net Credit Sales? a average Account Receivable Receivable Turnover Ratio=$400,000?$380,000=1.0526 The financial ratios above are commonly applied in much small business; however, those ratios remain to be very important to managers of large corporations (Longenecker, 2006). This is because the above ratios help managers to make the best decision that may increase wealth and profitability of their corporations as well detects the impending risk that may face their organizations (Charantimath, 2006).

The most important ratios that managers of large corporation use are liquidity ratios, solvency and profitability ratios. Those ratios are essential tools for corporate decision making. Advantages and Disadvantages of Debt Financing and Why an Organization Would Choose to Issue Stocks rather than Bonds to Generate Funds Debt financing has numerous advantages which include: debt financing allows business owners to have full control of the business unlike equity financing where ownership is shared among shareholder (Seidman, 2005).

Debt finance is easier to control and administer because business owners do not have to adhere to strict financial reporting as compared to equity financing (Whittington & Delaney, 2010). Debt financing provides business owners with an opportunity to raise large amount of capital. Debt finance allows small business owners to be exempted from tax liabilities on the income from loan borrowed. This is because interest on loan is not tax