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Importance of using a financial analysis
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Today, businesses need to utilize many tools to maximize profit and stay alive in the market. Several companies often look at financial ratios to better understand a company’s financial condition and their performance. All of the ratios play a large role in these companies, both individually, as well as collectively. There are several financial ratios which all calculate different things important to a business. Liquidity ratios measure the firm’s ability to meet short term obligations. It is important for a company to have good liquidity, which shows that the company has capital to pay expenses. The greater a company’s liquidity, may mean that it has less money tied up in assets. Activity ratios measure a firm’s utilization of assets. Assets …show more content…
Liquidity ratios can help show whether or not a company has enough cash to pay short term expenses to keep a company going. If there is a serious lack of liquidity, a company may need to convert some assets to cash or obtain more cash through certain means. Activity ratios can help someone understand the reason for a failing business through viewing possible changes in common use resources. In understanding the leverage and coverage ratios, there can be a greater ability to see if the company is taking on too much financial risk and if the company is able to sustain itself in servicing its debt. Profitability ratios show a company’s performance and condition through how much money the company has made after expenses. If the ratio reflects a low number, or negative number, things need to change. I believe these ratios are related because they all tie in to profitability and sustainability. I believe for a business to be successful, it needs to be profitable, which ties into many of these ratios listed. It also need to be sustainable, which plays into all of these ratios listed. To be the most profitable, a company will need to have good activity ratios, utilization of assets, good leverage and coverage ratios, the ability to finance and service debt, and have decent liquidity ratios showing that the company can meet short term obligations. All of these ratios support …show more content…
Members of a firm such as financial managers and accountants, prospective and current investors, prospective creditors, and accounting students, as well as many more people who may use these ratios. Although all persons listed above might use these ratios, they may have different motives for calculating these ratios. These ratios, when applied to different people, continually have the same meaning behind what they represent and stand for. All who calculate these ratios most commonly are looking to assets the company’s financial standing and position. The firm itself will be looking to find weak points in the business and see where and what changes need to be made.The firm looks for internal control purposes within the budgetary process and isolate problems before they get too big. The accountant uses these ratios to calculate information for other members of the firm to be able to interpret the company’s standing. Prospective and current investors may use these ratios to look into companies they have invested in or plan on investing in, to see what may be a proper investment, based on liquidity, potential, value and earnings. Prospective creditors would use these ratios to determine payback ability. Accounting students may use these ratios to simply crunch numbers, it does not have meaning besides where and when the calculation is applied. Many people can use these ratios if they have proper information to understand how well a
Troy, PhD., Leo. Almanac of Business and Industrial Financial Ratios. 30th edt. (1999) (page 159) Paramus, NJ: Prentice Hall.
This section will discuss ratio analysis for the following ratios: current ratio, quick (acid-test) ratio, average collection period, debt to assets ratio, debt to equity ratio, interest coverage ratio, net profit margin, and price to earnings ratio. Depending on the end user which ratio carries more importance, however, all must be familiar with ratio analysis. Details on each company's performance for each of these areas can be found in the attached ratio analysis worksheet.
Financial ratios are "just a convenient way to summarize large quantities of financial data and to compare firms' performance" (Brealey & Myer & Marcus, 2003, p. 450). Financial ratios are very useful tools in order to determine the health of a company, help managers to make decision, and help to compare companies that belong to the same industry in order to know about their performance.
I will be comparing five types of financial ratios through statement of comprehensive income and balance sheet, as follows:
The current ratio measures the ability of a business to pay back their liabilities. Kroger’s current ratio for both years was under one, which shows that Kroger has more current liabilities than current assets. This could predict that Kroger is not in good financial health at this time. However, some of their competitors have current ratios under one too. The grocery store industry trends to have lower liquidity ratios, because they keep lower levels of current assets. Their ongoing sales help pay upcoming liabilities. Still, business owners and investors would be looking for a current ratio over one at least.
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.
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.
Financial benchmarking is the process of “running a financial analysis [report] and making a comparison of the results [to] assess a company’s overall competitiveness, efficiency and productivity” (Debitoor, 2018). These analyses are often altered between ratio and financial trend. Ratio analysis or also known as financial ratio analysis “is a quantitative analysis of information contained in a company’s financial statements [and it] is used to evaluate various aspects of a company operating and financial performance such as its efficiency, liquidity, profitability and solvency” (Momoh, 2017). Financial trend analysis “[are] often used to make projections and assessments of [an organization] financial health … Analysts [typically]examine the past performance of their company, along with current financial conditions, to determine how their company will perform in the future” (Lewis, 2011).
In regards to the corporation’s balance sheet, it is necessary to place an importance on liquidity ratios to demonstrate the company’s ability to pay its short term obligations such as accounts payable and notes that have a duration of less than one year. These commonly used liquidity ratios include the current ratio, quick ratio, and cash ratio. All three ratios are used to measure the liquidity of a company or business. The current ratio is used to indicate a business’s ability to meet maturing obligations. The quick ratio is used to indicate the company’s ability to pay off debt. Finally the cash ratio is used to measure the amount of capital as well short term counterparts a business has over its current liabilities.
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
Information on the financial statement can offer an overview of a company’s performance over the past fiscal year. However, gaining crucial investment insights requires financial manipulation that yields financial ratios.
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.
“Ratios provide an extremely effective method of understanding company accounts. At their most basic this usually involves taking one figure from the published accounts and dividing it by another - however, this seemingly simple process can reveal an enormous amount about both the nature and performance of a company” (Leach, 1988). Based on DuPont’s calculations 2016, for their cash ratio was $0.52 cents of cash for every dollar of their current liabilities. The company maintains more than half of their cash flow. This helps to stabilize the assets of DuPont along with some of their other operating activities.
It simplifies the comprehension of financial statements. Ratios tell the whole story of changes in the financial condition of the business.
Ratio analysis is one of the most important and powerful tool in analyzing the financial position of the company where ratios are applied for evaluating the financial condition and act of the firm. Investigation and understanding of different accounting ratios gives a clear study and a better understanding of the financial position of the firm