Question

What are some of the uses of ratio analysis?  Select 5 ratios, show how they are computed, and explain what might cause the ratios financially and/or operationally to both decrease and decrease.

Answer 1

Ratio analysis is used to evaluate a number of issues with an entity ,such as its liquidity,efficiency of operations and profitability.It is quantitative method to evaluate company"s liquidity,operational efficiency and profitability by comparing information contained in its financial statements.It is a fundamental analysis.It used to look at trend over time for one company or to compare companies with in an industry or sector

Ratio analysis includes-

1.Profitability ratios-By this ratio we can get-

-how good a company is at making money?(profit)

-company"s competitive position in the market.(profit margin,company"s turn around etc.)

-this ratio calculated by income statement like sources of income and expenditure.

a.profit margin=Net profit/sales revenue

If profit margin is higher that means company is better than other.

b.return on assets=net income/total assets

c.Return on equity=net income/share"s holder equity

2.liquidity ratios-by this ratio we can get-

-how comfortable a company is to pay its debts in the short term?

a.Current ratio=current assets/current liability

higher ratio indicates lesser risk means better for company.

b.Quick ratio=(Current assets-current inventory)/current liabilities.

c.cash ratio=(cash+marketable securities)/current liabilities.

3.Solvency ratios=

How comfortable a company is to pay its long term debts?

Also known as leverage ratio or debt ratios

.a.Debt ratios=total liabilities/total assets

by this we get how mush debt debt is used to finance its assets.

-lower ratio is better for company

b.Debt to equity ratio=total debt(liabilities)/total equity.

4.activity ratios=Measure operational efficiency of a company.

-How well a company manages its working capital and long term assets to produce more?

Also known as efficiency ratios or assets utilization ratios.

a.Inventory turn over ratio= cost of goods sold/average inventory

Higher inventory turnover ratio means faster turnaround ,better for company.

b.receivables turnover=annual credit sales/account receivable

c.average collection period=365 days/receivables turn over ratio

5.Valuation ratios=used for investment decisions.

-know the right value of company.

Earning per share=net profit/no.of outstanding shares

P/E RATIO=price per share(current market value)/Earning per share

low P/E ratio means better for investment.