Question

For this week’s reflection, please write three complete and well composed paragraphs (in your own words) where you select three financial ratio and discuss what information the ratios provide management and how the ratios are used by management.

Answer 1

1. Net profit margin = Net profit / Net sales. This is one of the profitability ratios. This is quite important ratio and indicates that how much the firm has lost after net sales in all the expenses till it arrives at net income. This basically correlates the first and last accounts of the income statement which is the net sales and net income and this provides a clear picture of how ably in operating the company is able to convert its sales into its income after deducting all the expenses. The higher this ratio better is the functioning of the firm.

2. Acid test ratio = Quick Assets / Current Liabilities. This is a liquidity ratio and provides information how liquid the firm is in terms of its quick assets. Quick assets are the cash and cash equivalents, short term investments and receivables. As the name indicates it clarifies how quickly the liquid assets can be converted and used for the short term obligations when firm is in need.

3. Days sales outstanding = 360 / receivables turnover. This is a management efficiency ratio and considers turnover ratio as well. It indicates how long it takes for sales to procure from the receivables and add to the revenue. Simply it indicates the no of days it requires to collect its receivables. Shorter it is better is management and for this receivables turnover should be as high as possible.

4. Days Inventory ourstanding = 360 / Inventory turnover. This is a management efficiency ratio and considers the inventory turnover ratio as well. Simply it indicates the no of days it requires to sale all of its inventory from the day of its purchase for a firm. Shorter it is better is management and for this invenory turnover should be as high as possible.

5. Cash conversion cycle = Operating cycle - Days payable outstanding. This is very essential management efficiency ratio and takes into account all the other ratios. It indicates how fast company is converting cash into more cash. It represents the number of days a company pay for purchases, then sells them, and collects the amount due. This is an actual efficiency indicator.