Question

Financial ratio analysis is conducted by managers, equity investors, long-term creditors, and short-term creditors. What is the primary emphasis of each of these groups in evaluating ratios?

Answer 1

the primary emphasis of each of these groups are :

financial ratio analysis is conducted to understand the financial performance of the business in the current year, and also predict the financial performance of the business in the future.

the figures that are generated through the analysis of the various financial ratios like a. liquidity b. solvency 3. turnover ratio 4. profitability are thoroughly studied by ;

a) managers : the managers manage the wealth of the business. the entire wealth invested by the shareholders are taken care by the managers. the compensation of the mangers is directly linked to the financial performance of the business. the greater the profitability the greater will be their compensation. since, the overall performance of the business is entrusted to them, they are responsible for its success or failure . so, they compare the performance of the business with the previous years and with its peers. hence the the profitability ratio like the gross profit margin, net profit margin ,liquidity and solvency ratios which indicate the overall performance of the business is analyzed by them.

b) equity investors : they have invested their money into the business and are expecting returns on their investment. the greater the profitability of the company, the greater the returns will be distributed as dividends to the investors. if the company is growth intensive then the returns will be invested for further expansion and growth of the business and not distributed as dividends. they understand weather the earnings are high or low compared to previous years and industry average as well as the competitors that are existing in the same business. return on invested capital, EBITDA/sales ,PE ratio, dividend yield.

c) long-term creditors: they have invested their money in the business and are primarily concerned with the cash flows of the company and the earnings available to pay interest on debt. the greater the cash flows available in the business, the faster the payments will be made to the creditors. the ratios which help them ascertain this is the debt/equity ratio and times interest earned i.e ebit/interest expense.

d) short term creditors: they analyze the ratios to help them ascertain the ability of the firm to fulfill the short term obligations. the ratios like current ratio, receivables turnover ,accounts payable are of primary interest to them.