Question

Receivables can also be used to analyze the financial health of a company. Research the Accounts Receivable Turnover ratio for TWO companies in the same industry. Report back the ratios for these companies. Analyze these ratios and tell us, based only on this information, what company is in a better financial position. Is this what you expected, why or why not?

Answer 1

Compare and contrast essays are multi-paragraph compositions that explain ways in which two (or occasionally more) subjects are similar and different. In these essays, compare means describing similarities between the subjects. The essay on farmlife versus city would provide at least one paragraph on how people's lives in the city are like the lives of the people that live on a farm. Basically, the comparison tells what they have in common.

When a writer contrasts two things, he or she explains ways in which they are different. After completing a unit of study on where people live, students should be able to provide several details about how life on a farm can be vastly different from life in a city.

Again, compare and contrast essays can cover almost any topic and may pop up in a variety of subject areas. In order to make decisions about what to include, writers need to keep one thing in mind: relevance. Relevance helps determine which characteristics are worth comparing and contrasting. Your thesis will help you determine the relevance, or irrelevance, of facts. That means writers need a strong thesis statement.

This is a sentence that lets the reader know the topic and the argument the writer is making. Something like: While city life and farm life have few similarities, city life provides the hustle and bustle of many people, distinct noises, and social opportunities that are different from that of farm life. If this is the writer's thesis statement, then the essay should focus on details that are relevant to the hustle and bustle of city life, noises, and social activities available in the city versus on a farm. The thesis statement will help keep the writing focused on just a few ideas that are based on the overall topic.

HOW TO DETERMINE THE FINANCIAL HEALTH OF A COMPANY

1. Analyze the Balance Sheet

The balance sheet is a statement that shows a company’s financial position at a specific point in time. It provides a snapshot of its assets, liabilities, and owners’ equity.

Assets are what a company uses to operate its business. Liabilities refer to money that’s borrowed from other sources and needs to be repaid by the company. Owners’ equity represents the financing that owners, whether private or public, put into the business. It’s important to note that assets should always be equal to the sum of liabilities and owners’ equity. This relationship is the basis of the accounting equation: Assets = Liabilities + Owners’ Equity

Both assets and liabilities are displayed as either current or non-current on the balance sheet, indicating whether they’re short- or long-term. Short-term assets are those expected to be converted to cash within a year, while long-term assets are those not expected to be converted into cash within a year. Short-term liabilities, on the other hand, are those which are due within a year; long-term liabilities are not due within a year.

The balance sheet provides information on a company’s financial health by helping you analyze the following:

• How much debt the company has relative to equity
• How liquid the business is in the short term (less than one year)
• What percentage of assets are tangible and what percentage comes from financial transactions
• How long it takes to receive outstanding payments from customers and repay suppliers
• How long it takes to sell inventory the business keeps on hand

2. Analyze the Income Statement

The income statement shows a company’s financial position and performance over a period by looking at revenue, expenses, and profits earned. It can be created for any period using a trial balance of transactions from any two points in time.

The income statement generally starts with the revenue earned for the period minus the cost of production for goods sold to determine the gross profit. It then subtracts all other expenses, including staff salaries, rent, electricity, and non-cash expenses, such as depreciation, to determine the earnings before interest and tax (EBIT). Finally, it deducts money paid for interest and tax to determine the net profit that remains for owners. This money can be paid out as dividends or reinvested back into the company.

The income statement provides information on a company’s financial health by helping you analyze the following:

• How much revenue is growing over certain accounting periods
• The gross profit margin for goods sold
• What percentage of revenue results in net profit after all expenses
• If the business can cover its interest repayments on debt
• How much the business repays to shareholders versus how much it reinvests

3. Analyze the Cash Flow Statement

The cash flow statement provides detailed insights into how a company used its cash during an accounting period. It shows the sources of cash flow and different areas where money was spent, categorized into operations, investing, and financing activities. Finally, it reconciles the beginning and ending cash balance over the period.

The cash flow statement is one of the most important documents used to analyze a company’s finances, as it provides key insights into the generation and use of cash. The income statement and balance sheet are based around accrual accounting, which doesn’t necessarily match the actual cash movements of the business. That’s why the cash flow statement exists—to remove the impacts of non-cash transactions and provide a clearer financial picture to managers, owners, and investors.

The cash flow statement provides information on a company’s financial health by helping you analyze the following:

• The liquidity situation of the company
• The company’s sources of cash
• The free cash flow the company generates to further invest in assets or operations
• Whether overall cash has increased or decreased

4. Financial Ratio Analysis

Financial ratios help you make sense of the numbers presented in financial statements, and are powerful tools for determining the overall financial health of your company. Ratios fall under a variety of categories, including profitability, liquidity, solvency, efficiency, and valuation.

Some of the financial ratios you should know include:

• Gross profit margin: The percentage of profit the company generates after direct cost of sales expenses have been deducted from the revenue
• Net profit margin: The percentage of profit the company generates after all expenses have been deducted from revenue, including interest and tax from revenue
• Coverage ratio: The company’s ability to meet its financial obligations, specifically to cover its debt and related interest payments
• Current ratio: The company’s ability to meet short-term obligations of less than one year
• Quick ratio: The company’s ability to meet short-term obligations of less than one year using only highly liquid assets
• Debt-to-equity ratio: The percentage of debt versus equity that the company uses to finance itself
• Inventory turnover: How many times per period the entire inventory was sold
• Total asset turnover: How efficiently the company generates revenue from total assets
• Return on equity (ROE): The company’s ability to use equity investments to earn profit
• Return on assets (ROA): The company’s ability to manage and use its assets to earn profit

Financial ratios should be compared across periods and against competitors to see whether your company is improving or declining, and how it’s faring against direct and indirect competitors in the industry. No single ratio or statement is sufficient to analyze the overall financial health of your organization. Instead, a combination of ratio analyses across all statements should be used.

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