Question

Explain how the following users of financial statements might utilize the financial ratios:

• Managers
• Boards of Directors
• Short term lenders
• Stockholders

Which ratios would each group be interested in?

Answer 1

Managers

As a manager, the key factors for his decision making are the daily operations of the firm and hence understanding the efficiency and effectiveness of the resources being deployed for production. Some of the key efficiency ratios like ROA, ROCE and profitability ratios like Gross margin and operating margins are used.

Board Of Directors

As a board of director, the key purpose is to ensure long term value to shareholders. Some of the key ratios are profitability like net margin ratios, ROE or return on equity, Price to Earning ratios to signal value to share holders and also EPS or Earnings per share as EPS boost would support share valuation in the markets.

Short Term Lenders

For short term lenders, the key ratios are liquidity as they would be repaid on continuous basis through the surplus liquidity or cash at their disposal. Hence liquidity ratios like Current Ratio, Quick ratio and Cash ratio are used for decision making. Some of the turnover ratios like account receivable turnover, inventory turnover and payable turnover are also used by short term lenders for understanding the efficiency.

Stockholders

The main focus of stock holders is on the profitability as increasing profits signal cash flows to them. Hence Net Profit margin is a key ratio. In addition valuation ratios like Price to Earnings(P/E), P/BV and EV/EBITDA are used to take decision on investing in the stocks.