Question

7-4: Financial Ratio

Finanacial ratio analysis is conducted by four types of analysis: managers, equity investors, long-term creditors, and short-term creditors. What is the primary emphasis of each of these groups in evaluating ratios?

Answer 1

1: the managers are concerned with profitability ratios such as gross profit margin, net profit margin and operating profit margin. The managers performance in most cases is directly linked to the profitability of the business and hence they are concerned about the profits of the operations.

2: equity investors are concerned with profitability and efficiency ratios. Their dividend is linked directly with profitability and future prospects. They are concerned with the efficiency ratios since that gives the picture of the efficiency with which the investment made by them is being utilized. They’re also concerned with solvency of the company and ratios such as P/E ratio.

3: long-term creditors are generally concerned with the capital structure of the business. They need to assess the solvency of the company in the long term. If a company has too much debt in its capital structure, the long-term creditors wille be at risk.

4: short-term creditors are concerned with solvency ratios as well as liquidity ratios. This is because they need to know the safety of their loans to the company. They are also concerned with regularity of immediate payments for which they need to know their liquidity which can be assessed by way of current ratio and acid test ratios.