How to Use Financial Ratios to Maximize Value and Success of Busines - Assignment Example

Financial Ratios Name Institution Course RATIO ANALYSIS Calculations 2016 Current Ratio- 302/273 1.1 Quick Ratio 302-120/273 0.67 Inventory Turnover 1160/120 9.7 A/c Receivable Turnover (Days) 365*90/2900 11.33 Fixed Asset Turnover 2900/156 18.59 Total Asset Turnover 2900/458 6.33 Debt Ratio 286/458-286 1.66 Debt-to-Equity 286/172 1.66 Times Interest Earned 1271/26 48.89 Gross Profit Margin 1740/2900*100 60% Operating Profit Margin 1245/2900*100 43% Net Profit Margin 903/2900*100 31.14% Return on Total Assets (ROA) 1245/458*100 271% Return on Equity (ROE) 1245/172*100 724% Earnings Per Share 903/500 $1.81 Price/Earnings Ratio 5.50/1.81 3.04 Question 2 A Financial statement offers important information concerning a company’s strength and financial position in business. Ratio analysis refers to the creation of ratios by the use of certain components extracted in financial statements through the means that assist in identifying the weaknesses and strengths of the company. Ratios assist in measuring the comparative performance of diverse economic measures, which shows the company’s financial strength. When viewing the value of a dollar and each of its financial assessment, one can conclude its performance, but when applying ratios one gets a standardized assessment that is easier during interpretation. Ratios assists companies in analyzing their groups of data mostly found in a company’s financial statements. Most firms apply diverse definitions for a variety of ratios. The financial ratios can be categorized into five groups namely liquidity, profitability, efficiency, repayment capacity and leverage ratios. The discussion of the use of the five ratios will enable one in the examination of the company’s performance and financial health. Liquidity Ratio: liquidity is the measurement of the amount of cash possessed by a business and how fast the business can convert current assets into cash in a short period. Firms find it simple to convert assets such as trading securities, account receivables and inventory into cash in a short period (Bull, 2014, p. 8). Therefore, firms with large current assets can easily trade off their current liabilities without compromising their long-term assets. Every year, the liquidity ratio increases indicating that the firm is in a better position to offset its current liabilities before maturity. At the beginning, the account receivable for many firms seems to be poor and in other cases does not exist but as time progresses firms tend to improve, which increases their ratios on a yearly basis (Bull, 2014, p. 15). As a result, their liabilities are paid on time without any problems. Leverage ratio assesses the relative volume of capital supplied by debt holders and equity. This focuses on the extended period of solvency of a company. In summary, when the quantity of debt capital is relative to financing equity these enables a company become more leverage thus creating more danger to the owners. Contrary, higher leverage can be related with more expected returns. Debt ratio it assesses the definite proportions of equity and debt funds used in financing corporate assets. Repayment capacity inspects the company’s debt in terms of its statement of income relationship. The objective is to determine the distance a company’s earnings can reject before making the payment interests. An efficiency ratio measures the ability of the firm to use its assets in offsetting its liabilities efficiently. Efficiency ratios include inventory turnover ratio, assets turnover ratio and receivable turnover ratio. Efficiency ratio can help firms to measure their ability to generate income by efficiently using and managing their resources and assets. By evaluating the efficiency of its operations, the asset turnover ratio can measure the strength of a firm in generating income (Bull, 2014, p.23). Based on the amount of profit a firm generates, efficiency ratio indicates the effectiveness of a firm’s ability to run its assets. Poor management of assets by firm can cause problems in its liquidity. Profitability Ratios is a valuable tool for stakeholders in determining the ability of management to use the firm’s assets and owner’s equity to generate revenue for the company. Firms can use profitability ratios to determine its ability to generate income by comparing its statement of accounts. It uses return on investment of a firm based on the company’s accounts and assets (Bull, 2014, p. 36). The firm can use profitability ratios to determine if the company is generating any income as a result of investment. External users such as creditors and investors use profitability ratios to measure a company’s income capacity for investment decisions. Profitability can be used to determine whether the firm is generating enough revenue using its resources to sustain its operations. Profitability ratios can be classified as efficiency ratios since they evaluate how companies use their resources and assets to generate revenue (Financial Accounting Standards Board, 2012, p.11). Firms can benefit from using profitability ratios during solvency. Gross margin ratios measure the profitability of a firm when it trades its inventory. Like this firm, many companies use higher ratios when trading their account to get a higher percentage of profit. A firm can achieve higher ratio in two ways (Financial Accounting Standards Board, 2012, p.16). The first one is purchase inventory at a cheaper price. Retailers can get cheap prices when they trade their inventory with wholesalers and manufacturers at a discount price, which reduces their cost as their gross margin increases. Secondly, retailers can achieve higher ratio by increasing the prices of goods and asset at reasonable level. High prices can discourage consumers, which can affect the task. A high gross margin indicates that the firm is able to meet its operating expenses efficiently and effectively. Gross margin ratio can be used to fund other areas of business operations by determining inventory profits and percentage of sales (Financial Accounting Standards Board, 2012, p. 22). Based on many company’s ratio analysis, GPM increases which indicate good performance. Whereas, ROCE and NPM are stable throughout the financial year, which indicates that the firm is able to sustain its operation for a period. Gross profit margin ratio, net profit margin ratio and return on equity ratio are a list of profitability ratios. Other ratios include EPS, which indicate profit earned by every share of specific stock in a company arranged as a firm (Harvey, 2013, p.13). The PE ratio, which is the price earnings, evaluates the value of open traded companies stock in relation to its current earnings. Generally, when the relative value is higher than the current production it becomes greater in production for its future growth. It can also help in the reduction of dangers for the future production. Financial ratios have more impact to the firms’ performance. As a tool of analysis, it helps the business in realizing its weaknesses and strengths. They show if a company has money to satisfy its obligations. The analysis can be applied to determine a company’s viability if it is an ongoing business and to show if the return of satisfactory is being acquired for revenge purpose (Harvey, 2013, p.26). The device can also help corporate in revealing a quandary in some fields of the company’s performance and the institute correctional task. Through a daily scrutiny of important financial ratios, management may monitor if the corrective actions are effective. Financial ratios also play a vital role in during planning. Since the objective for company’s managers is to maximize the stakeholders wealth. The ratios permit management to transform goals into set objectives. For instance forcing all employees to optimize stakeholders’ wealth may not be effective. Moreover, setting objective in stipulations to particular ratios like inventory turnover or average collection period will probably give up better results, since financial ratios tend to be measurable, specific and simple to relate. Financial rations can be useful to other persons apart from the financial managers. For instance, credit managers may use the ratios on determining the extent to which credit can be awarded to their customers (Harvey, 2013, p. 30). Investors and security analysts us the ratios analysis to assist evaluate the investment worth to invest in. Bankers also use the tool of ratio analysis on determining whether to give loans to companies. Unions mostly use the financial ratios during the negotiations for a collective bargaining accords with employers (Harvey, 2013, p. 36). Job seekers and students can also perform financial ratio analysis of prospective employers to find out career opportunities. Financial ratios determine your firm’s productivity. There are various ratios, which can be applied, but all of them determine how well the task the firm is performing in using its capital, assets, turning over inventory and earning profits on each one dollar of revenues. The main aim of financial ratio analysis is to provide the management with some ways to see how the firm is performing in regards to past periods and how its doing compared to other firms in the same industry. Trendy analysis permits us to be able to analyze common movements in a company’s financial conditions by paying attention on patterns from the ratios in a period. QUIZ 3 The general basis of comparing firm’s performance is to consider ratio analysis in regards to companies in the same industry. This may help to highlight a company’s weakness and strengths to other companies in the industry. When you compare the financial rations between different firms, it gives you a big picture on which area to adjust in order to remain competitive in the business world. For instance when considering the liquidity ratios of two or more firms you will be able to deduce which company is struggling to offset it current liability more so the ones that have ratios below 1.0 each period of the year. Therefore, it indicates that firms having ratios less than 1.0 can use their assets to settle its liabilities. This shows the companies with current ratio more than one are performing well hence have the potential to attract more investors in their firm the counterpart in the same industry (International Symposium on Advancement of Construction Management and Real Estate, In Wang, In Ding, In Zou, & In Zuo, 2013, p. 10). The financial ratio can be viewed also as a link that reveals something concerning company’s tasks like the ratio involving the company’s current liabilities and assets or linking the receivable accounts and its yearly sales. These ratios assist an analyst in comparing a company’s financial state on a routine basis or in relative to other companies (International Symposium on Advancement of Construction Management and Real Estate, In Wang, In Ding, In Zou, & In Zuo, 2013, p.14). Ratios mainly standardize most components of financial information for disparities in the volume of a cycle in the financial information when creating similarities timely among the companies. For instance, the total income of IBM Company is usually often more in number to the Apple Computer since IBM is greater than the Apple. When the ratios are computed where net earnings is divided by the total assets, its relative performance is assessed further perfectly. In a financial ratio, success is shown when an analyst considers various points(International Symposium on Advancement of Construction Management and Real Estate, In Wang, In Ding, In Zou, & In Zuo, 2013, p.19). These include the debate where financial ratio can just involve a representative test of potential ratios. Other more ratios might be created in provision of other insights. In the banking industry, an analyst can employ special ratios in relation to the firms’ tasks in those companies. They also act as flags showing potential places of their weaknesses or strengths. A detailed analysis needs the scrutiny of other information as well (Stittle & Wearing, 2015, p.6). Financial ratio needs to be divided for the company to uncover the exact meaning. To illustrate further, this low ratio can be because of high denominator or low numerator where both of them are examined in broad ways before going into the conclusions. This ratio can only be helpful when compared to other standards like the ratio trend of a corporate, particular company’s trend ratio in analysis or the mentioned objective of the management (Stittle & Wearing, 2015, p. 17). When the ratios are applied in comparing one company to another, this can result in the dissimilarities in an organization’s accounting practices, which in the end results to the wrong conclusions of the expected results. In summary, financial ratios are viewed as the yardsticks of statistics, which link two digits that are often extracted from a company’s balance sheets and the income statements. These ratios are grouped into five categories. First, the liquidity ratio evaluates the capability of a company in achieving its expected responsibilities. Second is the Asset Management ratio that determines the efficiency of the company by employing more resources to create sales. The third ratio is financial leverage that evaluates a corporate effort in meeting long term and short period debt responsibilities. Fourth being profitability, which determines the company’s effort in creation of profits on assets, sales, and investment stockholder. Lastly, the market based which evaluates the investor’s market discernment of a company’s risk and performance. The trend analysis also provides the component of time when analyzing the financial ratio. This offers the analyst a broad view of a firm’s state than the analysis of financial ratio comparison. The affiliation of ROI to the turnover and margin can be applied in determining whether the two firms are deficient in supplying to a company’s profitability. The financial statements known as common size also contribute in the detection and monitoring of the trends of finance. In attaining additional knowledge about a company’s financial position, one should balance the industry averages and financial ratios. The more expanded a company is, the difficult it becomes during comparison. The ratio analysis of a firm is only perfect when viewed as a company’s quality financial statements on which it relies upon. EVA (Economic Value Added) being an evaluation of performance generated by a business group known as SS& Company. These evaluates the return on dollar developed a company to the expected return by shareholders in different capital sources for the company’s utilization. In conclusion, the companies can prefer to acquire vast comparable choices of accounting. In contrast, the review of economic inventions can be done which differentiates companies from their competitors thus this can result into low exact for comparison. Earnings being seen as the most relevant accounting performance summary evaluation, it holds only single capital statement aspect. We should ensure that an opportunity subsists in creating multi dimensional measures of financial statement. Based on research information, many firms indicate higher performance based on its profitability, liquidity, efficiency working capital ratios, shareholders ratios and long-term solvency. Most of the firms survive in competitive market where they can be easily purchased off but due to long-term investment, the firms continue to operate. Based on annual report and ratio analysis, majority of firms are stable in the market. Therefore, investors and analysts are attracted towards these firms for investment purposes. References Bull, R. (2014). Financial ratios: How to use financial ratios to maximize value and success for your business. Oxford: CIMA. Financial Accounting Standards Board. (2012). Statement of financial accounting standards. Stamford, CT: Author. Harvey, A. C. (2013). Dynamic models for volatility and heavy tails: With applications to financial and economic time series. Cambridge: Cambridge University Press. International Symposium on Advancement of Construction Management and Real Estate, In Wang, J., In Ding, Z., In Zou, L., & In Zuo, J. (2013). Proceedings of the 17th International Symposium on Advancement of Construction Management and Real Estate. Stittle, J., & Wearing, B. (2015). Financial accounting. Los Angeles: SAGE Publications. Read More