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Strengths and weaknesses of financial ratio analysis
Theoritical financial ratios
Strengths and weaknesses of financial ratio analysis
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Any successful business owner or investor is constantly evaluating the performance of the companies they are involved with, comparing historical figures with its industry competitors, and even with successful businesses from other industries. To complete a thorough examination of any company's effectiveness, however, more needs to be looked at than the easily attainable numbers like sales, profits, and total assets. Luckily, there are many well-tested ratios out there that make the task a bit less daunting. Financial ratio analysis helps identify and quantify a company's strengths and weaknesses, evaluate its financial position, and shows potential risks. As with any other form of analysis, financial ratios aren't definitive and their results shouldn't be viewed as the only possibilities. However, when used in conjuncture with various other business evaluation processes, financial ratios are invaluable. By examining Ford Motor Company's financial ratios, along with a few other company factors, this report will give a clear picture of how the company is doing now and should do in the future. This is a trend table of Ford's financial ratio for the previous five years: Ford Motor Co. (DE) Ratios 12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000 Return on Equity (%) 22.65 7.9 5.08 -70.04 29.07 Return on Assets (%) 1.19 0.29 0.1 -1.97 1.9 Return on Investment 8.13 5.62 5.87 2.23 11.24 Gross Margin 0.021 0.021 0.023 0.02 0.026 Operating Margin (%) 6.22 4.94 5.56 2.07 10.42 Net Profit Margin (%) 2.03 0.3 -0.6 -3.36 2.04 Quick Ratio 0.29 0.35 0.35 0.22 0.2 Current Ratio 0.47 0.52 0.51 0.37 0.33 Working Capital/Total Assets -0.22 -0.18 -0.16 -0.23 -0.28 Total Debt to Equity 8.61 13 25.67 18.3 6.05 Long Term Debt to Assets 0.35 0.38 0.41 0.44 0.35 Interest Coverage 1.69 1.18 1.11 0.3 1.76 This is a trend table of industrial average financial ratio for the previous five years in comparison: Industry Averages Ratios 12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000 Return on Equity (%) 17.22 4.20 -90.92 -0.37 16.89 Return on Assets (%) 3.56 0.71 -2.08 4.18 4.62 Return on Investment 9.42 4.31 5.42 2.16 13.39 Gross Margin .018 .018 .019 .019 .020 Operating Margin (%) 5.42 4.09 -3.02 7.05 8.11 Net Profit Margin (%) 2.89 1.43 -0.67 3.79 3.88 Quick Ratio 0.86 0.91 0.71 0.71 0.80 Current Ratio 1.36 1.46 1.13 1.57 1.26 Working Capital/Total Assets 0.10 0.10 0.01 0.04 .06 Total Debt to Equity 7.26 11.67 19.23 14.82 8.05 Long Term Debt to Assets 0.35 0.49 0.95 0.45 0.21 Interest Coverage 8.85 3.00 0.13 -1.63 6.48 The analysis of these ratios shows how Ford stands as a company for the past five years. Return on equity (ROE) reveals how much profit a company earned in comparison to the total amount of shareholder equity on the balance sheet. For long-term investing with great rewards, companies that have high return on equity ratios can provide the biggest payoffs. This ratio also tells investors how effectively their capital is being reinvested, so it is a good gauge of management's money handling skills. Ford is showing a considerable turn around in this area this past year, which could easily be due to changes in management. They are also reasonably following the industry in this area. Return on assets (ROA) tells how much profit a company generates for each dollar in assets. It measures the asset intensity of a business.
Ratio analysis are useful tools when judging the performance of a company by weighing and evaluating the operating performance (Block-Hirt). There are 13 significant ratios that can separate by four main categories, profitability, asset utilization, liquidity and debt utilization ratios. The ratio analysis covered here consists of eight various ratios with at least one from each of these main categories. These ratios were used to compare and contrast the performance of Verizon versus AT& T over the years 2005 and 2006.
Return on sales is decreasing and is below the industry average, but the goods news is that sales and profits have been increasing each year. However, costs of goods are increasing and more inventory is left over each year causing the return on sales to decrease. For 1995, it was 1.7% which is less than the average of 2.44% but is a lot higher than the bottom 25% of companies as seen in exhibit 3, which actually have negative sales return of 0.7%. Return on equity is increasing each year and at a higher rate than industry average. In 1995, it was 20.7%, greater than the average of 18.25% and close to the highest companies in exhibit 3, of 22.1% showing that the return in investment in the company is increasing, which is good for the owner.
The return on total assets (ROA) is an overall measure of profitability which measures the total effectiveness of management in generating profits with its available assets. This ratio indicates the amount of net income generated by each dollar invested in assets. The higher the firm's return on total assets, the better. Harley Davidson's return on total assets was 14.04% for 2001, 14.27% for 2000. These percentages are high and show an upward trend, this shows strong performance in this area for the past two years.
Organizations use financial statements and ratio analysis assess financial performance viability. The ratio analysis are used to identify trends and to perform organizational comparison (financial) with other companies within same industry. Ratio analysis, using data reported on the financial statements, are divided into five major categories: common size, liquidity, solvency, efficiency, and profitability. This paper will assess the financial stability of John Hopkins Hospital (JHH) using the five ratio analysis.
Description: Return on Equity (ROE) indicates what each owner’s dollar is producing in terms of net income that is the rate of return on stockholder dollars. ROE is a common metric for assessing the value of a firm and most investors look to ROE first when deciding where to allocate their capital. As such, it is also an important measure for a CEO to monitor.
In order to make inferences about a company’s financial condition, its operations, and its attractiveness as an investment we have analyzed financial ratios and compare ratios derived from SVU’s financial statements (see chart 1).
Ford Motor Company has been and till the date is known as the king of innovations in the automobile industry. Their research & development department and innovation of interchangeable parts in moving assembly lines resulted in extraordinary global extension for them. They are an old heritage who ruled and still doing impressive jobs in the global automobile market. Some prestigious motor brands are also owned by Ford.
This financial ratio analysis will help to identify Rolls-Royce’s strength and weaknesses during three years period from 2011 until the end of 2013. While it is a helpful tool for investors to make investment decisions base on profitability of the company, managers can make strategic decisions of the company. However, there are some limitations in using financial ratio analysis alone when make decisions. Comparing ratios with the industry norm and with the company’s rivals, the user of the financial ratio analysis will be able to anticipate future prospects. Rolls-Royce’s nearest rivals are General Electric (GE) and Pratt & Whitney, owned by United Technologies Corporation (UTC). These world 's top three companies are investing massively in R&D to satisfy demand of a booming global market for environmentally cleaner, energy efficient power engines that result in a huge number of orders of commercial airliners. All top
Before beginning an analysis of a company it is necessary to have a complete set of financial statements, preferably for the pas few years so that historical trends can be obtained. Ratios are a way for anyone to get an idea of the financial performance of a company by using the information contained in the financial statements. Ratios are grouped into four basic categories, liquidity, activity, profitability, and financial leverage. This document will use a variety of these ratios to analyze the firm, Sample Company, as of December 31,2000.
Monea, M. (2009). Financial ratios – Reveal how a business is doing? Annals of the University Of Petrosani Economics, 9(2), 137-144. Retrieved from http://www.upet.ro/eng
I have leant that ratio analysis offers better insight of a company’s financial position on the short-term and long-term basis. However, I would recommend that investor advice should be based on ratio analysis that considers ratios from several years. This will ensure that the investor is making an informed decision based on the company’s financial ratio performance trend.
...health of a company. For example, gross profit and net profit ratios tell how well the company is managing its expenses (Berman and Knight, 2008). Return on equity (ROE) explains how well the company is using its own assets/equity to generate returns (Berman and Knight, 2008). Additionally, return on investment tells whether the company is generating enough profits for its shareholders (Berman and Knight, 2008). Again, a higher ratio or value is desirable. A higher value means that the company is doing well and it is good at generating profits, revenues, and cash flows.
Upon examining P&G’s financial ability to meet short-term obligations, it is apparent that not only have their current liabilities exceeded current assets over the last three years, but close to half of their current assets have been tied up in inventories and other illiquid assets. For example, assessing both the quick and current ratio respectively shows that less than 70% of the firm’s current assets could be converted immediately to pay current commitments, but a little more than 90% of the firm’s liabilities would ultimately be covered. Though, based on industry average similar findings occur; therefore, it must not be uncommon for industries similar to P&G to
Ratios traditionally measure the most important factors such as liquidity, solvency and profitability, as well as other measures of solvency. Different studies have found various ratios to be the most efficient indicators of solvency. Studies of ratio analysis began in the 1930’s, with several studies of the concluding that firms with the potential to file bankruptcy all exhibited different ratios than those companies that were financially sound. Among the study’s findings were that the deciding factor of the predictor of bankruptcy should not be only a few ratios, as the measure of a company’s financial solvency may differ as the firm’s situations differ. The important question is to which ratios are to be used and of those ratios chosen, which ratios are given priority weight.
Return on assets (ROA) ratio: Net profit after taxes/Total assets. This ratio is calculated as net profit after tax divided by the total assets. This ratio measure for the operating efficiency for the company based on the firm’s generated profits from its total assets.