Assignment 5

Assignment 5

Introduction

Ratio analysis is used for analyses of financial statements to get a quick signal of a company's financial performance in various key areas. They identify trends of a company over a period of time or can be used to compare two companies at a single point in time and eliminate the impact of size of companies to make the comparison meaningful. Ratios are a good way to evaluate the performance of the business and identify problems (Gibson, C., (2012). They are good indicators of performance as they compared from the current year to those of one or more prior periods. With these ratios the performance of the company is also compared with that of competitors or other companies of similar size engaged in similar activities. The interpretation of financial ratios is fairly straightforward. This is to compare the ratio of your business with the statistics for your industry

Discussion

Financial ratios are very valuable indicators for any company. They indicate clear picture of the financial performance and financial situation of the company within the industry. In short, relationship that shows something regarding the activities of the company, like ratio between the current asset of the company and its current liability or among the debtors and turnovers. On the whole, ratios can be determined from the information that is available in the financial statements. In this section, we are going to discuss four major financial ratios of the company and its importance.

However, the use of ratio analysis may mislead the analyst because of the nature of financial statements. Financial statements are prepared on the basis of accrual basis of accounting. Many items other than cash and short term debt is open to manipulation and depend on estimates such as depreciation methods, inventory valuation methods, bad debts expense etc. Apart from that fixed assets are reports at historical cost rather than fair value. Inflation is another factor that can distort the ratios. Ratios themselves give no indication until they are compared to industry benchmarks which are not always easy to obtain and many companies may be going through different phases of their lifecycles as well. Hence ratios should be only used as a initial step and further investigation is warranted (Troy, L., (2008). The drawback of the ratios is that is does not indicates the qualitative factors rather the decision is based on the figures.

Importance of Ratios with Respect to Different Categories

Financial ratios are used to evaluate the strengths and weaknesses of an enterprise in terms of its financial position. A financial ratio is used as a magnitude for two different variables taken from the financial statements of an enterprise. There are many ratios which are standard ratios in accounting used to evaluate the financial position of a business. These ratios are often used by the management for evaluating their performance for the period. Financial ratios are used by different stakeholders, having their varied interests in the business, for example creditors use financial ratios in order to evaluate the liquidity position ...