Question

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Suppose you have landed successfully on a good career path full time position as a "Financial Analyst" with a multinational high tech corporation in our Silicon Valley hub.

On your first day on your job, your first project given is ratio/trend analysis of your new employer. Fortunately, you still remember financial analysis techniques discussed in your accounting 1B course final chapter 17, because your instructor required a lot of homework on that chapter not to mention those irritating discussion topics you had to bear all the way to the end of the term.

1. Which ratios should be used to help answer the following questions?

2. How efficient is a company in using its assets to produce sales?

3. How near to sale is the inventory on hand?

4. How many dollars of net income were earned for each dollar invested by the owners/shareholders?

5. How able is a company to meet interest charges as they fall due?

Please list as many measures, ratios, and any other analytical procedures you can think of. You do not have limit to our chapter 17 ratios.

Answer 1

1. There are 4 kinds of ratios which are used for analyzing the strengths and weaknesses of an organization - Solvency Ratios, Liquidity Ratios, Activity Ratios, and Profitability Ratios.

For analyzing the financial ratios of the organization, Profitability Ratios, and Liquidity Ratios should be used. For examples -

Current Ratio - Current Assets/Current Liabilities

Stock Turnover Ratio - Cost of Goods Sold/Average Inventory

Net Profit Ratio - Net Profit/Sales

Debts-to-Asset Ratio - Total Liabilities/Total Assets

Debt-to-Equity Ratio - Total Debt/Total Shareholders' Equity

Interest Coverage Ratio - Earnings before Interest and Taxes/Interest Payments.

2. A company's effectiveness in using its assets to produce sales is measured by the Asset Turnover Ratio - Sales/Total Assets. This Ratio should be less than or equal to 1.

3. The nearness of sales to the inventory is measured by the Days of Inventory in Hand. The formula is - (Net Revenues/Average Total Assets)*365. The less the number of days this is, the better for the organization.

4. For owners/shareholders, the dollars of net income earned by them is calculated by using the Return on common stockholders’ equity ratio, which can be calculated as such -

(Net Income-Preferred Dividend)/Average Common Stockholders' Equity.

5. A company's capability to meet interest charges can be calculated by the Interest Coverage Ratio - Earnings Before Interest and Taxes/Interest Payments. The closer this ratio is to 1, the better.