Question

TOPIC 1: The text book discusses about two dozen different financial ratios.  What is their purpose?  Can any ratio or combination of ratios predict a company's long-term viability?  Can you think of an example whereby one ratio incorrectly looks "good" only because another ratio is "bad"?

TOPIC 2: Distinguish between horizontal and vertical analyses. Why is the analysis of common-size statements called verticalanalysis? Why is horizontal analysis sometimes called trend analysis?

Answer 1

Answer of Topic 1

Categories	Ratios	Purposes
Liquidity measurement ratio	Current ratio	Proportion of current assets available to cover current liabilities
	Quick ratio	Most liquid current assets there are to cover current liabilities
	Cash ratio	An indicator of a company's liquidity
Profitability Indicator Ratios	Profit margin analysis	Percentage calculation to Profitability
	Effective tax rate	To compute tax rate on pretax income
	Return on assets	To know the degree of profitability on its total assets
	Return on Equity	To know profitability towards equity stockholders
	Return on Capital employed	To know profitability on total capital employed
Debt ratios	Debt ratio	To know the debt proportion of total assets
	Debt equity ratio	To know the debt proportion on its equity
	Capitalization ratio	To know the debt proportion on a companies capital structure
	Interest coverage ratio	To know how efficiency a company is to meet interest obligations.
	Cash flow to debt ratio	To know its proportion of cash flow over total debt
Operating performance ratios	Fixed asset turnover	To know the productivity of its fixed assets
Cash flow indicators ratios	Operating cash flow to sales ratio	To know the cash flows on its sales ratio
	Free cash flow to operating cash flow	To know the free cash flow to operating cash flow
	Cash flow coverage ratio	To know the cash flow cover on its net income
	Dividend payout ratio	To know the dividend payout as a percentage on EPS
Investment valuation ratio	Price to book value ratio	To know the proportion of price on its book value
	Cash flow coverage ratio	To know the cash flow cover on its net income
	Price to earnings ratio	To know how many times a earnings are covered by market price of a share
	Price to earnings growth ratio	To know how the price on its earnings growth
	Price to sales ratio	To know how the proportion of market price over sales
	Dividend yield ratio	To know how the proportion of dividend over market price of a share

The company’s long term viability can be determined by many ratios which include debt ratio and debt equity ratio and sales turnover ratio.

Inventory turnover ratio computed based on cost of goods sold is appropriate measure where as if it calculated on sales it results bad measure. Therefore, one way of measure is good and another way is bad.