Question

We still have some room for comment on various financial ratios that you can look up and explain to us. Please take a look above at the financial ratios that have been covered so far in this discussion and pick a new one, show us its formula, and explain what it tells us about an organization's financial health. However, to add yet another fresh question on this topic...

Applying this new knowledge about the various analytical techniques we discussed this week, if you were tasked with analyzing a company, where would you start? What would you look at? How would you approach the process of determining the financial health of an organization and possibly identify items that need to be fixed within the operation?

Answer 1

For Analaysing the company Financial Health, I would start from Analysing the Company's Financial Statement which includes the Income Statement, Balance sheet and Cash Flow Statements.

Profit Margin ratios should be analysed together with growth rate year on Year. If the margin is increasing it is a sign of good financial health, also the expenses should be analysed to see that they are in line with the revenue growth. Operating expense ratio should be anaylsed to assess how much is expended to generate the revenue. A lower operating expense ratio indicates the company is operating efficiently.

The Profit Margin ratio should be on higher side, the margin ratio low compared to Industry average or peers cannot be considered healthy. In case of low profit ratio, the revenue should be analysed for the pricing structure together with the quantity. The expenses should also be analysed for any startup costs or other factor leading to low profits.

The balance sheet should be reviewed starting with reviewing the current assets and the current liabilities. Current ratio should be analysed to assess whether the company can meet it short terms obligations.Current ratio should be as per the Industry average,it should not be so low that it suggests impending insolvency, or so high that it indicates an unnecessary build-up in cash, receivables or inventory.

Liabilities both Long term and Shoet term should be analysed in relation with the Company's assets. Debt to Assets and Debt to Equity ratio should be analyse to assess that the company's debt in realtion to Company's worth. A lower ratio is prefereable.

The cash flow statement should be analysed to assess that a company’s cash flow is sufficient to meet its short-term and long-term liabilities. The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations.

The company's market value to its book value should be compared to assess whether a stock is under- or over-priced. Genearally,a low market to book value indicates that company has a strong financial position in relation to its Market price of Stocks.The market to book value should be compared withe the industry average and other competitors to identify whether it is on a lower or higher side.