Profitability & Liquidity | Business Studies for GCSE/IGCSE - Year 11 PDF Download

The Importance of Profitability

• Profit is the earnings of a company after deducting total costs from total sales revenue.
• Profitability signifies the success level of a business.
• Profitability can be defined in two ways:
  • It is a measure of how effectively a business converts sales revenue into profit, indicating what percentage of sales revenue becomes profit.
  • It also reflects how well capital resources invested in the business generate profit.
• Profitability, presented as a percentage, enables assessment of business performance across different time periods and facilitates comparisons with other businesses.
• Multiple stakeholders show keen interest in profitability:
  • Investors scrutinize profitability extensively when evaluating potential investment opportunities. Higher profitability typically translates to greater potential rewards for investors.
  • Directors and managers evaluate profitability to gauge business success and to shape future objectives and strategy.
  • Employees may view profitability as grounds for negotiating higher wages or improved working conditions.

The Importance of Liquidity

• Liquidity refers to the capacity of a business to settle its short-term obligations, like payments to suppliers.
• A business that is unable to settle its debts is deemed illiquid:
  • Failure to pay suppliers may result in delayed delivery of raw materials or components, subsequently impeding production processes.
  • Inability to repay an overdraft could lead to withdrawal of banking facilities and deterioration of the business's credit rating.
  • Creditors may enforce cessation of trading activities and compel the sale of assets to recover the debts owed to them.
• Various stakeholders prioritize liquidity:
  • Suppliers seek assurance that a business can settle payments promptly for goods or services rendered.
  • Financial providers like banks require evidence indicating the business's capacity to repay loans or overdrafts.
  • Customers desire confidence in the supplier's ability to fulfill orders by ensuring efficient production and delivery processes.