Question

6. Ratio analysis 

A company reports accounting data in its financial statements. This data is used for financial analyses that provide insights into a company's strengths, weaknesses, performance in specific areas, and trends in performance. These analyses are often used to compare a company's performance to that of its competitors, or to its past or expected future performance. Such insight helps managers and analysts improve their decision making. 

Consider the following scenario: 

You work as an analyst at a credit rating agency, and you are comparing firms in the construction and engineering sector. One company in the portfolio of companies you are analyzing is a Chinese firm. This form stands out in the ratio analysis, because the company's financial ratios are substantially lower than identical financial ratios of the other firms in the sector. You do not dissect the results of the ratio analysis and categorize report this firm as an under performing company.

Which of the following statements about your analysis report is true? 

• The ratios provide an accurate and thorough representation of the Chinese company's performance 

• The analysis likely includes incorrect and misleading conclusions. 

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios are true or false? 

Statement True False 

• A company exhibiting a high liquidity ratio means it is likely to have enough resources to pay off its short-term obligations. 

• Market value or market-based ratios help analysts figure out what investors and the markets think about the firm's growth prospects or current and future operational performance.

• Asset management or activity ratios provide insights into management's efficiency in using a firm's working capital and long-term assets 

• One possible explanation for an increase in a firm's profitability ratios over a certain time span is that the company's income has increased 

• Debt or financial leverage ratios help analysts determine whether a company has sufficient cash to repay its short-term debt obligations

Ratio analysis is an important component of evaluating company performance. It can provide great insights into how a company matches up against itself over time and against other players within the industry. 

However, many tools and techniques, ratio analysis has a few limitations and weaknesses, 

which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply 

• A firm's ratios can lead to conflicting conclusions--some ratios might be good and some "bad." 

• Inflation can distort balance sheet data.

•  Ratio analysis is conducted using benchmarking techniques

Answer 1