Ratios Are Only One Way to Determine Financial Performance of a Company - Essay Example

FINANCIAL ANALYSIS al Affiliation) The business needs in depth analysis on the financial structure before the decision on the expansion or making additional expenditure on the business so that the actual returns and other financial factors are included in the operation of the business (Friedlob & Schleifer, 2003). The financial ratios that are applied by Snead’s Dry-Cleaning Company as Sheldon plans to take over the company are important so that he becomes aware of the actual position of the business financially. Some of the ratios that can be used in the company are current ratio, current liability to net worth ratio, total liability to net worth ratio, fixed asset to net worth ratio, collective period ratio, sales to inventory ratio, asset to sale ratio, sales to net working capital ratio, account payable to sales ratio, returns on sale and returns on net worth (Friedlob & Schleifer, 2003). These ratios will be useful to the business in situations such as when a lender determines the stability and the health of a business by looking at the balance sheet that is provided by the business. When Sheldon will need a loan from the bank, the financial ratios is an important strategy that will be used in giving out the loan. The banks will make the financial ratios part of the loan agreement. Sheldon in the strategy of obtaining a loan from the bank will need to keep the equity of the company above a given percentage or the current asset that the business has to a certain level of the current liabilities. Liquidity ratios Liquidity ratio of the company is important in the qualitative and quantitative strategy of the company. These ratios measure the amount of liquidity that the company is able to cover debts and the broad overview of the financial health. The current ratio measures the ability of the company to generate cash to meet the short term financial goals such as those that the company needs. Quick ratio can be used by Sheldon in determining the financial position of the company such that it will bring about the ability to access cash quickly to support the immediate demands of the company (Friedlob & Schleifer, 2003). This can help in actions such as hiring the additional employees that are required by the company. Quick ratio is also referred to as acid test and takes into account the current assets and current liabilities in the company. The quick ratio of Snead’s Dry Cleaning Company is as follows  =  = 0.5 The ration is below 1 and this makes it not much accepted. This shows that the company might have difficulty in achieving the goals and may not be able to take quick advantage of opportunities that require quick cash. Efficiency ratios Efficiency ratios are carried out after a period of time in the organization and this is important in giving insight into the area of the company such as cash flows, collection and operational results. Factors such as inventory turnover will enable Sheldon in determining the duration that it takes for inventories that are in the organization to be sold and get replaced during a year period (Bragg, 2000). Determining of this ration in Snead’s Dry Cleaning Company is significant as gross profit is earned each time there is occurrence of turnovers. The ratio is also important in the strategies of Sheldon and his uncle as it will enable them determines the improvements that can be made on the buying practices and also inventory management (Bragg, 2000). The ratio will also determine the necessity and the ability of implementing the recommendations that are made by Sheldon’s uncle such as pick and drop services, tailoring services and shoe and luggage repair. Sheldon is not sure about all of these recommendations, but some might work. The ratio will determine those that can work. Inventory to net working capital can be used in the company as it will allow determining the much of the company’s capital that is tied up in inventory. In general, the lower the ratio is, the better the situation of the business. The ratio then can be improved and this will allow investing more working capital in growth driven projects. Determining the ratio in the company will enable Sheldon in determining the investments that can be needed in the company. Profitability ratios The ratios are not use only in evaluation of financial viability of the business but also they are important in comparing the business to the others in the industry so that the needed improvements are made to make the business competitive. Net profit margins measure the much a company earns relative to its sales. The ratios in the strategies of the company will be essential in determining the expansions that can be made on the business. A company that has a higher profit margin than the other competitors is efficient in its operations and is flexible making the company being able to take on new opportunities that are available. In the strategies of the company, operating profit margin is also referred to as coverage ratios are important when determined in the business (Bragg, 2000). It will be different from the net profit margin as kit is impacted by taxes and expenses. Analyzing this margin is important as it will give better access on the ability to expand the company through additional debts or the other investments. Increasing the services that are provided by the company will enable the company have an increase in the ratios as there will be increased expenditures and handling of more operations. Return on asset is important in a company in implementing its strategies is important in management is utilizing the assets of the company. Returns on equity are also a strategic ration that can be utilized in the in relation to the investment that is made by the shareholders of the company. It will give the actual earning of the company with relation to the amount that is invested in the company. When Sheldon will decide in taking over the company, this ratio is important as it will enable him determine the amount that the company is able to take back to its investments and the amount that the additional services can be able to bring to the company. Total assets can also be compared to the net sales that are made by the company. The ratio analysis is a measure that will enable giving out the information about the ability of the company to make sales in the line with the tangible assets of the company. This analysis will also enable Sheldon determine the ability of using the resources that are available in the company in producing revenues from purchases in case he is to take over the company from his uncle or when he decides to buy the company. Leverage ratios Leverage ratios give a sign of the long-term creditworthiness of a company and to the extent the management is using long-term debt to sustain the operations of the business. Determining this in Snead’s Dry Cleaning will enable Sheldon determines and put up strategies that when implemented in the long term will enable the company reach the required levels and meeting the strategies of the company (Palepu, Healy & Bernard, 2000). Debt-to-equity and debt-to-asset ratios are used by bankers to see how the assets of the company are financed, whether it comes from creditors or investments of the own company, for example. In general, a bank will consider a lower ratio to be a good indicator of your ability to repay the company debts or take on additional debt to support new opportunities that the company is putting into place. Accessing and calculating the ratios The company can access the tools that are used to calculate the ratios online or can use the financial advisors of the company to come up with the right options that will enable proper strategies such that when Sheldon decides to take over the company, he will be able to meet the goals that are needed in the company; those that were recommended by the uncle and the others that he thinks are essential in the company for satisfaction of consumer needs and also attracting other customers to the company (Palepu, Healy & Bernard, 2000). Conclusion As noted in the essay, it is important to keep in mind that ratios are only one way to determine financial performance of a company. Beyond what industry a company is in, location can also be important. Regional differences in factors such as labor or the costs that are involved in moving of goods may also affect the result and the significance of a ratio. All these other factors should also be considered by Sheldon in management of the company and the additional services that are to be increased in the company. Financial analysis that is sound is those that entail examination closely on the data that is used to establish the ratios and also assessing the situations that the results are generated. This will make the results that are obtained from the analysis important and accurate in making financial decisions for the company. References Bragg, S. (2000). Financial analysis. New York: Wiley. Friedlob, G., & Schleifer, L. (2003). Essentials of financial analysis. Hoboken, N.J.: John Wiley. Higgins, R. (2003). Analysis for financial management. Homewood, Ill.: Dow Jones-Irwin. Palepu, K., Healy, P., & Bernard, V. (2000). Business analysis & valuation. Cincinnati, Ohio: South-Western College Pub. Rodgers, P. (2008). Financial analysis. Oxford: CIMA. Read More