Question

Answer the following questions regarding: Efficiency

1. Please describe in detail what each of the following ratio attempt to measure?

2. Where would you obtain such information?

3. For what period of time and what other comparisons would assist your analysis.

4. What management policies would have a positive affect on this analysis tool.

Answer 1

1Ans.

The Financial ratios help a company's potential and current investors better understand the overall health of the company as well as its condition in various specific categories. In addition, tracking financial ratios over a period of time is a powerful way to identify trends in their early stages.

Ratios are also used by lenders and business analysts to determine a company's financial stability and standing.

It's important to understand that financial ratios are time sensitive; they can only show a picture of a business at a given time. So the best way to use financial ratios is to conduct a ratio analysis on a consistent basis.

Financial ratios can be divided into five types of categories:

Liquidity or Solvency Ratios:-

The liquidity (or) solvency ratios focus on a firm's ability to pay its short-term debt obligations. As such, they focus on the firm's current assets and current liabilities on the balance sheet.

The most common liquidity ratios are the current ratio, the quick ratio, and the burn rate (interval measure). The quick ratio, as the name implies, determines how much money is available in the nearest term to pay current liabilities. The current ratio is a similar, but less stringent liquidity evaluation ratio. Burn rate measures how long a business can continue when current expenses exceed current income.

It's a common measure used in evaluating start-ups, which almost always lose money as they begin to do business. Burn rate answers the important question: how long at the current rate is the company going to be able to keep its doors open.

Financial Leverage or Debt Ratios:-

The financial leverage or debt ratios focus on a firm's ability to meet its long-term debt obligations.

It looks at the firm's long term liabilities on the balance sheet such as bonds.

The most common financial leverage ratios are the total debt ratios, the debt/equity ratio, the long-term debt ratio, the times interest earned ratio, the fixed charge coverage ratio, and the cash coverage ratio.

Although all slightly different, these financial leverage ratios all tell you about different aspects of the company's overall financial health and, in most instances, quantify shareholder equity.

Asset Efficiency or Turnover Ratios:-

The asset efficiency or turnover ratios measure the efficiency with which the firm uses its assets to produce sales. As a result, it focuses on both the income statement (sales) and the balance sheet (assets).

The most common asset efficiency ratios are the inventory turnover ratio, the receivables turnover ratio, the days' sales in inventory ratio, the days' sales in receivables ratio, the net working capital ratio, the fixed asset turnover ratio, and the total asset turnover ratio.

The asset efficiency ratios are particularly valuable in describing the business from a dynamic viewpoint. Used together, they describe how well the business is being run -- how fast its products are selling, how long customers take to pay and how much capital is tied up in inventory.

Profitability Ratios:-

The profitability ratios are just what the name implies. They focus on the firm's ability to generate a profit and an adequate return on assets and equity. They measure how efficiently the firm uses its assets and how effectively it manages its operations and answer such basic questions as "How profitable is this business?" and "How does it measure up to its competitors?"

Market Value Ratios:-

The market value ratios can be calculated for publicly traded companies only as they relate to stock price. There are many market value ratios, but a few of the most commonly used are price/earnings (P/E), book value to share value and dividend yield.

2)Ans.

On the basis of importance or significance, the ratios are classified as primary ratios and secondary ratios. The most important ratios are called primary ratios and less important ratios are called secondary ratios. Secondary ratios are usually used to explain the primary ratios.

Importance of ratios significantly varies among industries therefore each industry has its own primary and secondary ratios. A ratio that is of primary importance in one industry may be of secondary importance in another industry.

It's important to keep in mind that ratios are only one way to determine your financial performance. Beyond what industry a company is in, location can also be important. Regional differences in factors such as labor or shipping costs may also affect the result and the significance of a ratio. Sound financial analysis always entails closely examining the data used to establish the ratios as well as assessing the circumstances that generated the results.

The new businesses work in a short-term, reactive way. This offers flexibility - but can cost time and money as you move from getting the business going to concentrating on growing and developing it.

The best option is to balance your ability to respond rapidly with a clear overall strategy. This will help you decide whether the actions you take are appropriate or not.

At this stage of the they should ask to if there are any internal factors holding the business back,

When it comes to the business' success, therefore, developing and implementing sound financial and management systems (or paying someone to do it for company) is vital.

3) Ans.

The making a proper use of ratios, it is essential to have fixed standards for comparison. A ratio by itself has very little meaning unless it is compared to some appropriate standard. Selection of proper standards of comparison is a most important element in ratio analysis. The four most common standards used in ratio analysis are; absolute, historical, horizontal and budgeted.

Absolute standards are those which become generally recognised as being desirable regardless of the company, the time, the stage of business cycle, or the objectives of the analyst. Historical standards involve comparing a company’s own’ past performance as a standard for the present or future.

In Horizontal standards, one company is compared with another or with the average of other companies of the same nature.

The budgeted standards are arrived at after preparing the budget for a period Ratios developed from actual performance are compared to the planned ratios in the budget in order to examine the degree of accomplishment of the anticipated targets of the firm.

4) Ans.

The common size ratios" and "liquidity ratios," for example:-may be unfamiliar. But nothing in the following pages is actually very difficult to calculate or very complicated to use. And the payoff to you can be enormous. The goal of this document is to provide with some handy ways to look at how your company is doing compared to earlier periods of time, and how its performance compares to other companies in your industry. Once you get comfortable with these tools you will be able to turn the raw numbers in your company's financial statements into information that will help to better manage the business.

Financial ratio analysis can be used in two different but equally useful ways. The company can use them to examine the current performance of your company in comparison to past periods of time, from the prior quarter to years ago. Frequently this can help you identify problems that need fixing. Even better, it can direct your attention to potential problems that can be avoided. In addition, that can use these ratios to compare the performance of the company against that of the competitors or other members of the industry.

At the end of any review process, therefore, it's vital that work plans are prepared to put the new ideas into place and that a timetable is set. Regularly reviewing how the new plan is working and allowing for any teething problems or necessary adjustments is important too. Today's business environment is exceptionally dynamic and it is likely that you will need regular reviews, updates and revisions to your business plan in order to maintain business success.