Methodological issues with financial ratios - Essay Example

The paper is an attempt to analyze the accuracy of the statement taking the evidence from the last 10 years from the research work published. Use of Financial Ratios Financial ratios are used by the company stakeholders as they have different kind of interest in the concerned company. The shareholders assess the ratios and take the decision whether the performance of the company would be profitable for them, thereby take the investment decisions. The company management analyzes the flaws of the performance of past years and tries to improve it in the future years using ratio analysis tool.

The creditors of the company try to find that the company is creditworthy anymore or not (Moyer, McGuigan and Kretlow, 2008, p.58). By doing the comparable analysis of ratios an investor or a prospective investor take the decision that which firm is better to invest, from where they can get the best return when the company management has the interest that how their company is performing with respect to the industry standard (Hitchner, 2011, p.103). When doing the ratio analysis for the above mentioned various purposes then the user should make sure that he has considered the various factors which affect the variables of the ratio. . The two companies may be in same industry, but their size and their focus areas can be different, so it would not provide the accurate result by doing the ratio analysis without taking the factors associated with it (Brigham and Ehrhardt, 2010, p.109). Two companies may not follow the same accounting standards, or a company can change the accounting standards they are following in recent years.

The taxation rules of different states or countries are different as well as the political condition also. A multinational company has to face different inflation, different taxation rules throughout the world. So whether doing the trend analysis or cross sectional analysis an analyst should consider these factors. There are also technical factors associated with this issue. The analysts use many statistical tools which take the assumption that the data is normally distributed but in reality it doesn’t happen, and the outcome of the analysis not become fruitful.

A research study was performed by taking the data of 66 listed Malaysian firms and the data was of the period 1980 to 1996. The sample firms were taken from 3 different industries. It is seen by the researchers while doing that research that only current asset percentage was conformed to normal distribution, which supports the fact that all data used in the statistical tool for performing ratio analysis is not normally distributed which is assumed by the analysts generally. For doing the ratio analysis effectively the researcher used three types of transformation techniques namely square, square root and natural log.

The square and square root process proved as ineffective as they consider the data as normally distributed, which the natural log process don’t. The researchers