Question

We have covered several ratios in this unit that users of financial statements can work with to evaluate a company’s performance. However, not all ratios are important for or applicable to all organizations. In particular, service organizations have different business models than manufacturing organizations.

Using Facebook as a company, explain which financial ratios would be applicable to the company and which would not. State the reasons for your assertions.

Answer 1

Facebook, Inc. is an American social media conglomerate corporation and as such in services.

The ratios that are not valid for facebook are as follows :-

1) The inventory turnover ratio -  It measures the effectiveness of a company’s manufacturing process. This ratio shows how many times a company sells and replaces its inventory over a specific period of time. It is measured by dividing the cost of goods sold by the average balance in inventory. Since Facebook doesn't have any inventory and COGS it is not applicable.

2) Unit Contribution Margin Ratio - The contribution margin ratio is calculated by taking the difference between total revenue and total variable costs and dividing this figure by total revenue. As such facebook doesn't sold goods that have units attached with it.

3) The days sales in inventory ratio measures the average number of days that a company holds on to inventory before selling it to customers:

Days sales in inventory ratio = 365 days / Inventory turnover ratio

Facebook doesn't have any inventory hence this ratio is not applicable for facebook

The ratios that are valid for facebook are as follows :-

1) The current ratio measures a company’s ability to pay off short-term liabilities with current assets:

Current ratio = Current assets / Current liabilities

This is applicable for facebook as company will have current assets and liabilties.

2) nThe debt ratio measures the relative amount of a company’s assets that are provided from debt:

Debt ratio = Total liabilities / Total assets

This is applicable for facebook as company will have Liabilties and assets such as loans, Office building , patents etc.

3) The interest coverage ratio shows how easily a company can pay its interest expenses:

Interest coverage ratio = Operating income / Interest expenses

4)  Return on assets ratio = Net income / Total assets

The return on equity ratio measures how efficiently a company is using its equity to generate profit. The company source of revenue are many such as sponsor ads etc that forms part of revenue and positive side of net income.