Financial ratios outline the performance of a firm as compared to its previous years’ performance as well as making a comparison between the firm and the industry. (Shim & Siegel, 2000) These two types of analysis are performed either through performing the trend analysis…
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There are different ways in which financial ratios can be improved by the firm and hence its performance. However, it is critical to note that financial ratios can also be improved with the help of creative accounting techniques such as use of different depreciation methods, inventory value methods etc.
Financial ratios are typically chracterised into five groups and each group consists of different ratios that outline the performance of the firm in that category. For example, liquidity ratios comprises of current ratio as well as acid test ratio. In order to improve upon the liquidity ratios of a firm, a firm can discipline its use of working capital. Since liquidity ratios mostly indicate the firm’s ability to pay off its short term liabilities with its short term assets therefore it is really important that both the current assets as well as current liabilities are managed in optimum manner. In order to improve this ratio, a firm can decrease its reliance on the short term finance and shall encourage the use of internally generated funds to finance its short term working capital requirement. Since current assets are considered as non-productive assets it is therefore important that a balance must be achieved between the current assets and current liabilities to bring the ratios in most favorable condition.
Similarly, efficiency ratios indicate the efficiency with which the assets of the firm are managed by the managers. To improve the efficiency ratios, a firm can further tighten its credit extension policy to improve its receivable turnover. This can also be achieved by making the sales activity more robust so that inventories are rotated more frequently rather than piling them up after their production. A higher inventories turnover therefore indicates the ability of the firm to convert its inventories into cash or receivables through sales generation.
Profitability ratios can be
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(Financial Ratios Essay Example | Topics and Well Written Essays - 500 Words)
“Financial Ratios Essay Example | Topics and Well Written Essays - 500 Words”, n.d. https://studentshare.org/miscellaneous/1563805-financial-ratios.
The financial ratio helps to find out the performance of the firm over the years and its state of affairs. It used to analyze the functional effectiveness of the firm comparing with the competing firms. Financial ratios help to compute various financial statements and formulate new business-investment policies or to arrive at any management decision.
Finance and Accounting
Ratio analysis is a useful tool for analyzing a company, to predict about its future, but the result might get wrong if the factors of the variables are not taken in consideration. LEV and Sunder (1979) raised some basic questions like the structural relationship of the analyzed firms, the size of the firm; these factors are taken in consideration or not.
In the year 1979 in their research paper Lev and Sunder raised the issue that the ratio analysis done by the researcher is often motivated by the tradition and convenience, they generally not consider the theoretical background of the variables of the concerned ratio.
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