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Mba Snhu 503 Financial Ratio Analysis

By:   •  June 10, 2018  •  Coursework  •  688 Words (3 Pages)  •  1,069 Views

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While financial ratios may vary across industries, they serve as solid indicators of companies’ performance and financial stability at a given point in time providing both investors and manager with a better understanding of the company’s financial standing and position within the market. As an analytical tool, rations form a basis of comparison between figures found on financial statements and are useful when compared to similar indicators of companies (Lan, 2012).

Liquidity ratios, are an indicator of whether or not a company’s existing assets provide the ability to meet its short-term debt obligations. This data can be found in the company’s balance sheet and measure a company’s ability to maintain its operations moving forward. Problems with liquidity are often considered to be an early warning sign of significant operational problems (Peavler, 2017).

Solvency ratios, on the other hand, are an indicator of a company’s ability to meet its long term debt commitments. In a nutshell, the solvency ratio provides investors and managers with an understanding of whether or not a company has a positive net worth (Secord, 2015).

An additional indicator utilized by investors and managers to gauge the fiscal health of a company is the profitability ratio. This is the financial metric used to evaluate the ability of a company to generate profit relative to revenue, balance sheet assets, operating costs, and shareholders’ equity during a set period of time (CFI, 2018). By focusing on controlling operating costs, companies can impact their operating income percentage.

By properly managing inventory levels, managers can significantly impact profit and loss since inventory valuation directly impacts a company’s profit margin, working capital, and shareholder’s equity (Saint-Ledger, n.d). By monitoring and analyzing these rations to gauge a company’s fiscal strengths and weaknesses, managers have a greater ability to make informed decisions that can have a positive impact on working capital and allow them to better manage liabilities.

Liquidity measures how quickly an item can be converted to cash. Liquidity is the ability to pay off short term debts. A company with adequate liquidity may have enough cash to pay bills but can be in financial ruin in the future. Look at the quick ratio of the company which is the (current assets – inventories)/current liabilities. The higher the ratio the better off the company is.

Solvency measures a company’s ability to meet long term debts. The solvency ratio measures the size of the company after taxes. Solvent companies own more than they owe; they have a positive net worth and can manage their debt. There are a few solvency ratios that we use debt to equity, debt to asset, and interest coverage. Rising debt to equity can cause the company to have higher interest rates, high debt to asset ratio can mean financial risk, but in interest coverage a higher ratio means the company has better ability to cover their interest expense. A solvency ratio of 20% or more usually means the company is sound. Lower than that shows a higher probability of a company being in default on debt.

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