Question

What are some advantages and disadvantages of Asset Management (Activity) Ratios?

Answer 1

Activity /Asset Management Ratios is defined as

An activity ratio is a type of financial metric that indicates how efficiently a company is leveraging the assets on its balance sheet, to generate revenues and cash. Commonly referred to as efficiency ratios, activity ratios help analysts gauge how a company handles inventory management, which is key to its operational fluidity and overall fiscal health.

Advantages of Ratios/Ratio Analysis

1. Ratio analysis helps in forecasting and planning in areas such as costs, sales, and projecting cash flows and profits and future business planning

2. Ratio analysis can be used in budgeting and like sales budget may be prepared with the help of analysis of past sales.

3. Ratio analysis helps to measure operating efficiency like the usage of assets or resources of the company in fact, the solvency of a firm depends upon the sales revenues generated by utilizing its assets.

4. Ratio analysis helps in the Communication of the organization's positions and progress in various activities

5. Ratio analysis helps in performance control of departments or divisions, and cost controls of the organization

6. Ratios are the best tools of comparison between two companies in an industry, or two departments in the company, It helps to concentrate on inefficient organizations

7. Ratios help in the decision making of an organization - during the time of granting loans or acquiring other companies, we do ratio analysis to identify the financial strengths or weaknesses of the target company

Disadvantages

1. Ratios are calculated from financial statements of the data in financial statements is inaccurate, the ratios become invalid and may lead to wrong interpretations

2. Ratios derived from historical data may not useful for comparison, since the situation prevalent at that time ae different from current conditions

3. If the accounting policies used in financial statements are different from one another then the ratios derived from such financial statements may not be useful for comparisons

4. The non-availability of Benchmarks which are set to be called ideal ratios leads to a lack of standard comparison. the current ratio is said to be ideal if current assets are twice the current liabilities. But this conclusion may not be justifiable in case of those concerns which have adequate arrangements with their bankers for providing funds when they require, it may be perfectly ideal if current assets are equal to or slightly more than current liabilities.

5. Ratios are used for only quantitative analysis and the ratios cannot determine the qualitative factors of a company.

6. If the financial statements are prepared in such a way to show good ratios, then such ratios computed from such a balance sheet cannot be used for scanning the financial position of the business.

7. Ratios consider only one variable and compare the same, due to this the other key variables that are not considered may significantly affect the decision making of the companies