SCHOOL OF BUSINESS AND MANAGEMENT

BMMF 5103
MANAGERIAL FINANCE

RATIOS RELATING TO A COMPANY’S PROFIRTABILITY, LIQUIDITY, SOLVENCY

AND MANAGEMENT EFFICIENCY

JANUARI 2018 SEMESTER

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 TABLE OF CONTENTS

1.0 The balance sheet and sales data Page 3

2.0 Precautions when using ratio analysis Page 7

- To make financial decisions
- Ratios for internal financial analysis
- Stocks are most attractive within an industry

3.0 Method analysts use ratios to analyze firm leverage Page 12

- Firm leverage ratio
- Ratios convey more important information
- The level of indebtedness or measure the ability to service debt
- The relationship between the level of indebtedness and risk
- Order for an increase leverage success

4.0 References Page 16

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1.0 The balance sheet and sales data

Given :- Debt/net worth 60%

Acid test ratio 1.2
Asset turnover 1.5 times
Day sales outstanding in accounts receivable 40 days
Gross profit margin 30%
Inventory turnover 6 times

Answers for Balance sheet

a) Cash = RM 27,268
b) Accounts receivable = RM 9,372
c) Inventories = RM 10,360
d) Plant & equipment = RM 11,840
e) Total assets = RM 59,200
f) Sales = RM 88,800
g) Cost of goods sold = RM 62,160
h) Accounts payable ( total assets ) = RM 59,200

Step 1 : Find debt

Debt / networth = 60%

𝐷𝑒𝑏𝑡
= 60%
𝐶𝑜𝑚𝑚𝑜𝑚 𝑠𝑡𝑜𝑐𝑘 + 𝑟𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠
𝐷𝑒𝑏𝑡
= 60%
𝑅𝑀 15,000 + 𝑅𝑀 22,000
𝐷𝑒𝑏𝑡
= 60%
𝑅𝑀 37,000
𝐷𝑒𝑏𝑡
= 0.6
𝑅𝑀 37,000
𝑥 = 0.6 ( 𝑅𝑀 37,000 )
𝑥 = 𝑅𝑀 22,200 𝐷𝑒𝑏𝑡
Hence, debt is RM 22,200

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Step 2 : Find account payable ( total assets )

Total assets Note :

Capital = common stock +
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 retained earnings

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = 𝑅𝑀 22,000 + 𝑅𝑀 15,000 + 𝑅𝑀 22,000

𝑥 = 𝑅𝑀 59,200 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
Hence, account payable or total assets is RM 59,200

Step 3 : Find assets turnover

𝑆𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝑥
1.5 =
𝑅𝑀 59,200
𝑥 = 1.5 ( 𝑅𝑀 59,000 )
𝑥 = 𝑅𝑀 88,800 𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠
Hence, total sales is RM 88,800

Step 4 : Find gross profit margin

𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
= 30%
𝑆𝑎𝑙𝑒𝑠
𝑥
= 0.3
𝑅𝑀 88,800
𝑥 = 0.3 ( 𝑅𝑀 88,800 )
𝑥 = 𝑅𝑀 26,640 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
Hence, gross profit is RM 26,640

Step 5 : Find sales

Note :
𝑆𝑎𝑙𝑒𝑠 = 𝑅𝑀 88,800
Sales = sales – gross profit
𝐿𝑒𝑠𝑠 ∶ 𝐶𝑜𝑠𝑡 𝑔𝑜𝑜𝑑𝑠 𝑜𝑓 𝑠𝑜𝑙𝑑 = 𝑅𝑀 𝑥
𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑅𝑀 26,640
𝑥 = 𝑅𝑀 88,800 − 𝑅𝑀 26,640
𝑥 = 𝑅𝑀 62,160 𝐿𝑒𝑠𝑠 𝐶𝐺𝑂𝑆
Hence, cost goods of sold is RM 62,160

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Step 6 : Find day sales accounts receivable

Day sales account receivable = 40 days

365
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 =
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟
365
40 𝑑𝑎𝑦𝑠 = 𝑥
(𝑅𝑀 88,800)
𝑅𝑀 88,800
365 = 40 ( )
𝑥
365𝑥 = 40 ( 𝑅𝑀 88,800)
𝑅𝑀 3,552,000
𝑥=
365
𝑥 = 𝑅𝑀 9,731.51
𝑟𝑜𝑢𝑛𝑑 𝑥 = 𝑅𝑀 9,732.00 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
Hence, account receivable is RM 9,732 after round

Step 7 : Find inventory

Inventory turnover = 6 times

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑒𝑛𝑑𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝑅𝑀 62,160
6 𝑡𝑖𝑚𝑒𝑠 =
𝑥
6𝑥 = 𝑅𝑀 62,160
𝑅𝑀 62,160
𝑥=
6
𝑥 = 𝑅𝑀 10,360 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Hence, inventory is RM 10,360

Step 8 : Find assets turnover

𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝑅𝑀 88,800
1.5 𝑡𝑖𝑚𝑒𝑠 =
𝑥
𝑅𝑀 88,800
𝑥 =
1.5
𝑥 = 𝑅𝑀 59,200 𝐴𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 Hence, assets turnover is RM 59,200

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Step 9 : Find cash

𝐶𝑎𝑠ℎ + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒

(𝐴𝑐𝑖𝑑 𝑡𝑒𝑠𝑡 𝑟𝑎𝑡𝑖𝑜) 𝑄𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐶𝑎𝑠ℎ + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
1.2 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑥 + 𝑅𝑀 9,732 − 𝑅𝑀 10,360
1.2 =
𝑅𝑀 22,200
1.2 (𝑅𝑀 22,200) = 𝑥 + 𝑅𝑀 9,732 − 𝑅𝑀 10,360
𝑅𝑀 26,400 = 𝑥 + 𝑅𝑀 9,732 − 𝑅𝑀 10,360
𝑥 = 𝑅𝑀 26,400 − 𝑅𝑀 9,732 + 𝑅𝑀 10,360
𝑥 = 𝑅𝑀 27,268 𝐶𝑎𝑠ℎ Hence, cash is RM 27,268

Step 10 : Find plant & equipment

𝑃𝑙𝑎𝑛𝑡 & 𝑒𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑎𝑠ℎ − 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝑥 = 𝑅𝑀 59,200 − 𝑅𝑀 27,268 − 𝑅𝑀 9,732 − 𝑅𝑀 10,360
𝑥 = 𝑅𝑀 11,840 𝑃𝑙𝑎𝑛𝑡 & 𝑒𝑞𝑢𝑖𝑡𝑚𝑒𝑛𝑡
Hence, plant and equipment is RM 11,840

Table 1 : Balance sheet

Balance Sheet
RM RM
Sales revenue 88,800
Less : Cost goods of sold 62,160
Gross profits 26,640

Assets
Current assets:
Cash 27,268
Accounts receivable 9,732
Inventories 10,360
Plant and equipment 11,840
Total assets 59,200

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 Liabilities and capital
Current liabilities:
Accounts payable 59,200
Debt 22,200
Stockholders’ equity:
Common stock 15,000
Retained earnings 22,000
Total liabilities and capital 59,200

2.0 Precautions when using ratio analysis

- To make financial decisions
- Ratios for internal financial analysis
- Stocks are most attractive within an industry

The financial statements are a very important document for an investor in determining any decision on
the investment to be made. Referring to Brigham, E. & Houston, J. ( 2015 ), defines that the financial
statements are a form of reporting and official records relating to financial activities or positions of a
business entity and others involved in the issuance of such statements. Clear and responsive financial
information will be presented in a structured and easy-to-understand form to ensure that all involved
get the full information of the activities of a business entity. Referring to a businessdictionary.com
defining the financial statements is a summary of reports showing the use of funds that have been
entrusted by shareholders or borrowers in carrying out their business activities and outsourcing from
time to time the fundamental financial position.

There are three main principles in the financial statements, first of all, a balance sheet showing assets,
liabilities, share holdings and the present value of a business entity. Second is the income statement or
profit and loss account where this statement will show a comprehensive coverage of gross income, net
income, expenses, profit and loss and includes the length of time that a business entity is carrying on
its business activities. It can describe the operation and ability of the entity in doing a business activity.
With this financial statement available, it can assist one in obtaining clear, accurate and audible
information relating to the business of an entity in order to assist in analyzing the entity's ability and
resilience in the market. ( Gitman, L. & Zutter, C., 2013 ).

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There are several characteristics of ideal financial statement among others are as follows: -

2.1. Depict True Financial Position and audited

The information contained in the financial statements should be a true and correct idea taken on the
financial position of those concerns. There is no important information that must be held when
preparing this statement and is not hidden to shareholders or investors. The financial statements
prepared must be certified by the auditors as the information contained in the statement is valid and
true.

2.2. Effective presentation, attractive and briefly

The financial statements should be presented briefly and clearly in order to be easy-to-understand
by the reader. Someone who is inexperienced with accounting terms can also easy-to-understand
the statement clearly without any hassle. This attractive features will increase the use of the
statements. For example the financial statements should be provided in such a way as like outlined
the important information so that it attracts readers' points. The financial statements are presented
very concise and compact. Readers will be able to formulate ideas about numbers and
understanding of information more clearly. On the other hand, if the figures are given in detail then
it will be difficult to assess the work of the business.

2.3. Relevance
Financial statements should be relevant to the objectives of a business entity. This will possible
when the person preparing these statements is able to properly utilize the accounting information.
The information which is not relevant to the statements should be avoided, otherwise it will be
difficult to make a distinction between relevant and irrelevant data.

2.4. Easiness and Representative

The financial statements need to be provided with ease. The balance of the different ledger account
should be easily to taken to these financial statement. Calculation work should be minimal as
possible while preparing these financial statement. Statement size should not be too large. The
columns that will be used to provide the information are also be less. This will enable to time
savings in providing the statement. While for representative must represent the economic
phenomenon that he intended to represent in order to perfection, neutral and free from mistakes.

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 2.5. Suitability
The results of financial analysis should be compared with the previous year's statement. The
statement can also be compiled with the same numbers of other concerns. Sometimes the budgeted
figure is given along with the current figures. A comparable figure will make the statement more
useful. For example, The Companies Act, 1965 has made it mandatory to provide figures for the
previous year in the balance sheet. The numerical comparisons will enable appropriate assessment
of anxiety work.

2.6. Analytical representation and promptness

This information should be analyzed in such a way that similar data are presented in the same place.
Relationships can be made in similar types of information. This will help in analysis and
interpretation of data. Financial statements should be prepared and presented at the earliest. Soon
after the end of the financial year, the statement must be ready.

2.7. Materiality, neutral and complete

Excluding or blaming it may affect the decisions made by users based on financial establishment
of certain reporting entities. Do not have any inclination, accidental, weighted, stressed,
emphasized or manipulated. Includes all information required for the user to understand what is
being reported. (any words to describe an item or any note)

2.8. Reliability and Free From Error

Free from material errors and omissions and may depend on users to submit loyalty. There is no
mistake in the omission in the description of this phenomenon, the process used to produce reported
information has been selected and used without any in-process error, however, not entirely accurate.

2.9. Prudence and Accruals

Be careful when evaluating under uncertainty. Should not allow excessive or underestimate assets,
liabilities, income or expenses. Reflect the effects of transactions and other events and
circumstances on the economic source of the reporting entity

Referring to Titman, S., Keown, A. & Martin, J. ( 2014 ) dictating the ratio analysis is a quantitative
and comprehensive analysis contained in the financial statements. These analyzes are used as a
measurement and assessment method in terms of operational performance, financial, efficiency,
liquidity, profitability and solvency. With the use of such analytics allows investors to track and warn
early about the improvement or deterioration of a company's performance.

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Financial ratios are comparisons of the account matrix or category of financial statements. This
relationship between the accounts of the financial statements to helps investors, creditors, and internal
company management for understand the extent to which business performance and also a few factors
need to be improved. Financial ratios are the most common and widely used tool for analyzing the
financial position of a business very easy to understand and easy to calculate. This financial ratio also
can be used to compare different companies in different industries. Given the ratio of only
mathematical proportions based on proportion, large and small companies can use ratios to compare
their financial information unaudited or audited after . In a sense, the financial ratio does not take into
account the size of the company or the industry. The ratio is simply a rough estimate of the financial
position and performance, ( Brigham, E. & Ehrhardt, M. 2014 ).

Ratios allow to compare companies across industries, large and small, to identify their strengths and
weaknesses, profit and loss, increase or decrease, grow or shrink and others. Financial ratios are often
divided into seven main categories: liquidity, solvency, efficiency, profitability, market prospects,
investment leverage, and coverage.

The most useful ratios for a financial manager’s to anaylze internal financial analysis are liquidity
ratios, leverage ratios and profitability ratios.

a. Liquidity ratios
Liquidity ratios is to analyze the ability of a company to pay off both its current liabilities as
become due like monthly instalment as well as their long-term liabilities as they become current.
In other words, these ratios show the cash levels of a company and the ability to turn other assets
into cash to pay off liabilities and other current obligations. Liquidity is not only a measure of
how much cash a business has and it’s also method to measure of how easy it will be for the
company to raise enough cash or convert assets into cash. Assets consist of accounts receivable,
trading securities, and inventory are relatively easy for many companies to convert into cash in
the short term. Thus, all of these assets go into the liquidity calculation of a company. A few are
the most common liquidity ratios like quick ratio, acid test ratio, current ratio, working capital,
working capital ratio and also times interest earned ratio, ( Dhaliwal, D. S., Heitzman S., & Zhen
Li, O. 2006).

The current ratio is calculated as:

Current Ratio = Current asset / Current liability

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b. Leverage ratios

Financial leverage ratios also knows as equity or debt ratios, method to measure the value of
equity in a company by analyzing its overall debt picture. These ratios either to compare debt or
equity to assets as well as shares outstanding to measure the true value of the equity in a business.
In other words, the financial leverage ratios measure the overall debt load of a company and
compare it with the assets or equity owned by a company. This shows how much of the company
assets belong to the shareholders rather than creditors and when shareholders own a majority of
the assets, the company is said to be less leveraged. In other hands, when creditors own a majority
of the assets, the company is considered highly leveraged. All of these measurements are
important for investors to understand how risky the capital structure of a company and if it is
worth investing in. A few are the most common financial leverage ratios like debt ratio, debt to
equity ratio and equity ratio, ( Brigham, E. & Ehrhardt, M. 2014 ).

The debt ratio is expressed and calculated as:

Debt ratio = Total Debt / Total asset

c. Profitability ratios

Profitability ratios is to compare income statement accounts and categories to show a company’s
ability to generate profits from its business operations. Profitability ratios focus on a company’s
return on investment in inventory and other assets including common stock. These ratios
basically show how well companies can achieve profits from business operations and
investments. Investors and creditors can use profitability ratios to judge a company’s return on
investment based on its relative level of resources and assets. In other words, profitability ratios
can be used to judge whether the companies are making enough operational profit from all assets
or otherwise. In this sense, profitability ratios relate to efficiency ratios because they show how
well companies are using all companies assets to generate profits. Profitability is also important
to the concept of solvency and going concern. This are some of the key ratios that investors and
creditors consider when judging how profitable a company should be like gross margin ratio,
profit margin, return on assets, return on capital employed, and return on equity, ( Paul. M. Healy,
Krishna. G. Palepu 2012).

Return on equity is expressed as a percentage and calculated as:

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 Return on Equity = Net Income / Shareholder's Equity

An analyst will decide on the most attractive stocks in an industry based on several things like company
background, stock, price, market, strength and others. Usually as an investor, background companies
are a priority in analyzing stocks that have been traded in open markets. The history of a company that
has been listed on this board plays a major role in ensuring the capability and superiority of the
operations to remain secure in the market and provide attractive returns to all investors who buy the
shares. Subsequently, investors will also see time offer, offer price and historical increase including
dividends that have been granted for a given period. This usually known as technical analysis. This
allows investment decisions to be performed in good condition and can give investors the desired or
desired returns. In other words, investors will also directly look at the level of investment risk made on
the stock. There are a lot of calculation methods and ratios to be used by all types of investments to
make sure the investor's decision is best like relative valuation is a method of valuing a firm by
comparing standardized valuation metrics with those of similar companies, and it is generally the
starting point in peer comparison analysis. It is really quite simple: First, choose relevant ratios, such
as price-earnings (P / E), price-to-sales (P / S), enterprise value / EBITDA (EV / EBITDA) to the
investment decision, then find these ratios for each company in the peer group and see how each
company stacks up to the rest. There are four (4) main basic elements in stock valuation are the price-
to-book (P/B) ratio, the price to earnings (P/E) ratio, the price to earnings growth (PEG) ratio and
dividend yield, ( Schmidt, Tobias, Dowling, Michael J., & Lechner, Christian, 2006).

3.0 Method analysts use ratios to analyze firm leverage

- Firm levarage ratios
- Ratio can convey more important information
- The level of indebtedness or measure the ability to service debt
- The relationship between the level of indebtedness and risk
- Order for an increase leverage success

Financial leverage ratios also knows as equity or debt ratios, method to measure the value of equity in
a company by analyzing its overall debt picture. These ratios either to compare debt or equity to assets
as well as shares outstanding to measure the true value of the equity in a business. In other words, the
financial leverage ratios measure the overall debt load of a company and compare it with the assets or
equity owned by a company. Financial leverage ratios also knows as equity or debt ratios, method to
measure the value of equity in a company by analyzing its overall debt picture. These ratios either to
compare debt or equity to assets as well as shares outstanding to measure the true value of the equity
in a business. In other words, the financial leverage ratios measure the overall debt load of a company
and compare it with the assets or equity owned by a company, ( Ross Kirkham, 2012).

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According Maria L (2014), in determining the firm's financial leverage, analysts will look in detail in
relation to the firm's debt utilization factor. This will give a clear picture of the firm's ability to handle
debt problems. This leverage ratio is also known as long-term debt. Usually analysts will assess long-
term debt as well as short-term debt. With a decision that demonstrates the firm's ability to repay the
debt and the firm's loans. It will reduce fears and warn early indicating that the firm is capable or
otherwise. These firm debts will be analyzed if the firm can not afford to pay for a long period of time
and can affect its business activity based on several ratios such as equipment sales, asset purchases and
warrants for bankruptcy.

Regression analysis is given of the following examples

Y = α0 + β1Li + β2L + β3P + ε
Where: -
Y = Dependent Variable
α = Constant Value
β = regression coefficient
Li = liquidity
L = Leverage
P = Profitability
ε = the regression residual

Table 2 : Example Case Study of Correlation from 21 companies, which covered the period from
2010 to 2014 and sources of data from Bursa Malaysia Journal of Humanities, Language, Culture and
Business (HLCB), Hamidah, R. & Muhammad Khairul Hidayat, N. (2018).

Data sources = Bursa Malaysia

Yearly basis = (5 years) 21 companies

Correlations
ROA Current Ratio ROE Debt Ratio
ROA Pearson Correlation 1 .282 .872 -.282
Sig. (2-tailed) .004 .000. .004
N 105 105 105 105
Current Ratio Pearson Correlation .282 1 .228 .069
Sig. (2-tailed) .004 .019 .482
N 105 105 105 105

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 ROE Pearson Correlation .872 .228 1 -.220
Sig. (2-tailed) .000 .019 .024
N 105 105 105 105
Debt Ratio Pearson Correlation -.282 .069 -.220 1
Sig. (2-tailed) .004 .482 .024
N 105 105 105 105
** Correlation is significant at the 0.01 level ( 2-tailed )
* Correlation is significant at the 0.05 level ( 2-tailed )

The result indicates that ROE has the strongest impact on company's performance with magnitude
0.0872, Current ratio and Debt Ratio have the significant impact on company performance with
magnitude 0.282 and -0.282.

According Gomes, J.F., & Schmidt, L. ( 2010 ), leverage ratios is to measure how leveraged a company
is, and a company's degree of leverage ( debt load ) is often a measure of risk. It is also the long term
debt assestment to predcict about the future possibilities for comparison using year by year basis. For
example, when the debt ratio is high, the company has a lot of debt relative to the assets. It is thus
carrying a bigger burden in the sense that principal and interest payments take a significant amount of
the company's cash flows, and a hiccup in financial performance or a rise in interest rates could result
in default. When the debt ratio is low, the principal and interest payments don't command such a large
portion of the company's cash flow and the company is not as sensitive and alert to changes in business
or interest rates from this perspective. However, a low debt ratio may also indicate that the company
has an opportunity to use leverage as a means of the responsibly growing the business. In general, a
high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy
with all debt obligations. However, low debt-to-equity ratios may also indicate that a company is not
taking advantage of the increased profits that financial leverage may bring.

The most useful ratios that can convey more important information credit to anaylze liquidity ratios,
leverage ratios and profitability ratios. The liquidity ratio is to analyze the ability of a company to pay
both current liabilities as maturities such as monthly installments as well as long-term liabilities when
it becomes current. After that, the financial leverage ratio is also known as equity or debt ratio, a method
for measuring the value of equity in a company by analyzing overall debt portfolios. Lastly, for the
profitability ratio is to compare accounts and income statement categories to show the ability of the
company to generate profits from its business operations. These three ratios play their respective roles
in gathering all the information and data to enable analysts to make relevant and good decisions. These

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ratios will be used as a measurement tool for assessing the level of indebtedness as well as the ability
to repay debt. These three ratios have their own tasks that are interconnected with each other.

The relationship between the level of indebtedness and risk shown a positive relationship. In terms of
liquidity, which is represented by the ratio obtained that liquidity has a significant relationship and
impact on the performance of this company. The results supported by previous studies by Qasim (2011)
state that Liquidity has a significant impact on the firm's indebtedness, risk and performance. The
second is in terms of leverage ratio that has been represented by the ratio of debt, the result shows that
the leverage ratio has a sign in both the impact and the relationship with company performance is
mainly attributable to indebtedness and risk factors, this result is supported by Akinmulegun (2014).
Third is in terms of profit, it is expressed and calculated as return on equity (ROE). the results show
that Profit has a significant relationship and the impact on the company's performance and the
company's ability to solve the company's indebtedness and risk level. This result is supported by a
previous study by Vinayagamoorthi, (2015) states that profit has a significant impact on firms
performance.

Table 3 : Relationship between liquidity, leverage and profitability with a firm’s level indebtedness
and risk

Ratios Relationship Supported

Journal
Liquidity Significant and positive relationship with the level of Qasim ( 2011 )
indebtedness and risk under company performance
Leverage Significant and positive relationship with the level of Akinmulegun
indebtedness and risk under company performance ( 2014 )
Profitability Significant and positive relationship with the level of Vinayagamoorthi
indebtedness and risk under company performance ( 2015 )

The relationships of the above three ratios can tell the level of the ability, the degree of failure, the
early preliminary bankruptcy or otherwise.

According Hamidah, R. & Muhammad Khairul Hidayat, N. (2018), the order to increase leverage
success in a business is the first where the company has a strong and stable business activity or
operation. It is in ensuring that the company can always increase its income from time to time and can
also ensure its earnings are able to pay off debt. Later, the company should also ensure that productivity

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is constantly improving and remains outstanding. This is because this productivity can help the
company continue to thrive and always face it. The company is also required to provide the perfect and
good requirements and infrastructure as it enables the company to further increase its production
without any additional high costs.

Subsidiary companies can also play an important role in ensuring the holding company continues to
remain in the balance sheet and revenue generation continues to grow from time to time. This is because
it is able to offset the performance of each of its subsidiaries with business diversification. Among the
most important of the companies is internal management, including financial management of the
company. Employees or employees should be responsible for managing the company in good and
perfect condition. Good and good financial management, such as the management of indebtedness,
should be in line with the acquisition and assets of the company. Companies need to provide a good
financial plan so that the company will remain strong and viable, ( Dimitrov, V., & Jain, P. C. 2008).

( 4500 words )

4.0 Referens

Akinmulegun W.L . (2014). The Effect of Initial Public Offering on Company Performance : A Case
Study on Asia Cell in Kurdistan Region.Vol.5, No.18, 2014.

Brigham, E. & Ehrhardt, M. (2014). Financial management: Theory and practice. Ohio, OH: South-
Western - Cengage Learning.

Brigham, E. & Houston, J. (2015). Fundamentals of financial management. Ohio, OH: South-
Western - Cengage Learning.

Dhaliwal, D. S., Heitzman S., & Zhen Li, O. (2006). Taxes, leverage, and the cost of equity capital.
Journal of Accounting Research, 44(4), 691–723. http://dx.doi.org/10.1111/j.1475-
679X.2006.00214.x

Dimitrov, V., & Jain, P. C. (2008). The Value Relevance of Changes in Financial Leverage beyond
Growth in Assets and GAAP Earnings. Journal of Accounting, Auditing and Finance.

Gitman, L. & Zutter, C. (2013). Principles of managerial finance. Boston, MA: Pearson Prentice
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Gomes, J.F., & Schmidt, L. (2010). Levered returns. Journal of Finance, 65, 467-494.
http://dx.doi.org/10.1111/j.1540-6261.2009.01541.x

Hamidah, R. & Muhammad Khairul Hidayat, N. (2018). The Effect Leverage, Liquidity And
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Culture and Business (HLCB). Vol. 2: No. 7 (January 2018) page 9-15 | www.icohlcb.com |

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 eISSN: 01268147

Maria L (2014). Effect of Leverage on Performance of Non-financial Firms Listed at the Nairobi
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[Online]. Retrieved on Februari 10, 2018

http://www.businessdictionary.com/definition/financial-statement.html

Paul. M. Healy, Krishna. G. Palepu (2012). Business and economics : Using Financial Statements :
Business Analysis Valuation : Mason, OH : South-Western - Cengage Learning

Qasim, Y. S. (2011). The impact of IPOs on the values of directly competing incumbents. Strategic
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