Question

How does a firm use financial ratios? Who else might use financial ratios and why?

Answer 1

Financial ratios are used the managers to determine the financial performance of a company when compared to its peers. They help analyze the strengths and weaknesses of a business when measured against a benchmark industry performance. It helps in identifying if the company is performing as the set goals and is in line with achieving the mission of the organization. Ratios analysis is done by financial managers to measure the efficiency of the day to day operations primarily measured through activity ratios. Solvency ratios on the other hand help the business understand if it has enough cash to meet its obligations. Profitability ratios help analyze the overall profitability derived on assets and the return that the shareholders are deriving out of the capital employed.

Other users of financial ratios include investors, creditors , analysts among others. Creditors are most interested in liquidity ratios to measure if the company has the short term ability to pay their obligations. Long term lenders measure the degree of protection for their loans through coverage ratios. Investors analyze the return for their investment through profitability ratios majorly using ROE as their benchmark ratio. Analysts use the activity ratio to ascertain if the enterprise is using the assets employed in an effective manner.