Question

There are three categories of financial ratios: liquidity, solvency, and profitability. Using the SEC data for Macys, found here:

https://www.sec.gov/cgi-bin/viewer?action=view&cik=794367&accession_number=0000794367-18-000036&xbrl_type=v#

Describe what each category tells the user about the financial health of a company.

Choose three ratios in each category and describe what the ratios tell the user about the company.

How are financial ratios used to evaluate a company?

Discuss what the numbers would be compared against for analysis.

Calculate each ratio for your companies.

What do the ratios tell you about each of your companies?

Answer 1

LIQUIDITY RATIOS:

These ratios indicate the company’s ability to meet its short term obligations. Higher the ratio, better is the ability to meet short term obligations and higher is the probability that the creditors will be paid in time

SOLVENCY RATIOS:

These ratios indicate the ability of the company to meet its short term as well as long term obligations.

Higher the ratio lower will be the risk of default on the part of the company to pay interest , principles due and other obligations

PROFITABILITY RATIOS:

These ratios indicate the return sales and investments

LIQUIDITY RATIO:

Current ratio is calculated by dividing current asset by current liability. It indicates the ability to meet obligations within one year

Quick ratio is calculated by dividing the quick assets (Cash or cash equivalent) by current liabilities. This indicates ability to meet immediate obligations

SOLVENCY RATIOS:

Debt to equity ratio is calculated by dividing liabilities by shareholders equity.This indicates what portion of the total liabilities can be paid by shareholders equity

Equity Ratio is calculated by dividing total equity by the the total assets.This ratio tells us what portion of total assets are funded by equity

Times interest earned ratio is calculated by dividing Income Before Interest and Taxes (EBIT) by interest expense. This ratio tell us the ability to pay interest from current years profits

PROFITABILITY RATIOS

Operating margin is calculated by dividing operating income by sales. This ratio tells us how much is the margin of profit in the sales revenue

Return on asset is calculated by dividing net income by total asset.This ratio tells us about efficiency of managing assets to generate profits

Return on equity is calculated by dividing net income by shareholders equity. This ratio tells us what return the common shareholders are getting from their investment.

Financial ratios are used to evaluate a company from point of view of company’s current profitability, financial health of the company and future growth and prospects.

All the ratios needed to be compared by analysts with industry benchmark as well as its own performance over earlier years.