Question

1.Chapter 2 covers financial ratios. Financial ratios are calculated from a company's financial statements, and they can be used to determine how well a company is performing. Discuss in detail, the difference between a performance measure and a performance referent and provide a complete example of each.

2.Identify and discuss 5 different financial ratios, show how they are calculated (formula and data sources), and what the ratios seek to identify.

Answer 1

a performance measure is a metric against which the organization's performance can be measured. The stakeholders,investors measure the performance of the organization with the help of these performance metrics. the creditors can gauge the paying capacity and the cash flows generated in the organization with the help of these performance metrics and can be in a better position to decide whether to lend to the organization or not. the shareholders can make a decision for investing with the help of theses ratios. it helps them decide the current performance of the organization as well a the expected future cash flows.

for example a high debt /equity ratio may discourage creditors to lend loans to the company as it already under burden of debt.

when the profitability ratios and return ratios are not favorable for the business, then the stakeholders may not invest in the company.

performance referent : standalone ratios may not make much sense to a person viewing the business from the outside. therefore, there should be some performance referent against which the performance of the business can be measured . for example the net profit margin ratio is 35% . but as we compare this with the previous years performance which was 45% or compare it with the peers working on the same industry then we might be better able to gauge the performance.

5 financial ratios :

liquidity ratio

current ratio : current assets/current liabilities : 41829/31806 = 1.31

data source : investing.com

the current ratio of johnsons and johnsons is 1.31 which is a very poor indictor of its liquidity . the ideal current ratio is more than 2.

it measures th level of liquidity in the organization. How much current liabilities can be met with the existing current assets in the business. the higher the ratio the better is the liquidity performance of the business.

performance measurement indicator :

return on assets NI / total assets: this is a performance measure, it indicates how much return on the asset base of the company.it determines the efficiency with which the company is using its assets to generate positive earnings.

the net income of johnsons and johnsons for the year ending 2017 is : $16540

total assets = 155658

therefore, the net income/total assets : 10.63%

return on equity : NI /equity it indicates how much money a company generates on the shareholders invested capital.

net income = $ 16,540

equity = $ 73979

16540/73979 = 22.36%

interest coverage ratio : EBIT/interest this ratio indicates how much the company will be better be able to interest with the operating profit it generates after paying the operating expenses.

EBIT = 20259

INTEREST = 726

EBIT/ INTEREST = 27.9

THE HIGHER THE RATIO, BETTER IT IS . IT INDICATES THE COMPANY THEN VERY COMFORTABLY PAY THE INTEREST OBLIGATION WITH ITS OPERATING PROFIT.

operating performance ratios : dividend payout ratio : dividend is paid out to the shareholders for the return on the funds invested by them in the company. the proportion not paid as dividends is either paid for debt or reinvested back in the business.