1. When is trend analysis useful in analyzing ratios?
2. Do "Rules of Thumb" approaches to ratio analysis offer any value to; the financial manager, investor, or financial institution. Why or Why Not?
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1.When is trend analysis useful in analyzing ratios?
(a) When evaluating the performance of the company - Any successful business owner is constantly evaluating the performance of her or his company, comparing it with the company's historical figures, with its industry competitors, and even with successful businesses from other industries. To complete a thorough examination of your company's effectiveness, however, you need to look at more than just easily attainable numbers like sales, profits, and total assets. You must be able to read between the lines of your financial statements and make the seemingly inconsequential numbers accessible and comprehensible. This massive data overload could seem staggering. Luckily, there are many well-tested ratios out there that make the task a bit less daunting.
(b) When looking for strengths and weaknesses - Comparative trend ratio analysis helps you identify and quantify your company's strengths and weaknesses, evaluate its financial position, and understand the risks you may be taking. As with any other form of analysis, comparative trend ratio techniques aren't definitive and their results shouldn't be viewed as gospel. Many off-the-balance-sheet factors can play a role in the success or failure of a company. But, when used in concert with various other business evaluation processes, comparative ratios are invaluable. (Source: http://www.va-interactive.com/inbusiness/editorial/finance/ibt/ratio_analysis.html).
(c) When financial analysts are implementing plans - Ratios are highly important profit tools in financial analysis that help financial analysts implement plans that improve profitability, liquidity, financial structure, reordering, leverage, and interest coverage. Although ratios report mostly on past performances, they can be predictive too, and provide lead indications of potential problem areas. Ratio analysis is primarily used to compare a company's financial figures over a period of time, a method sometimes called trend analysis.
(d) Comparing with competition - Through trend analysis, you can identify trends, good and bad, and adjust your business practices accordingly. You can also see how your ratios stack up against other businesses, both in and out of your industry. However, there are several considerations you must be aware of when comparing ratios from one financial period to another or when comparing the financial ratios of two or more companies.
· If you are making a comparative analysis of a company's financial statements over a certain period of time, make an appropriate allowance for any changes in accounting policies that occurred during the same time span.
· When comparing your business with others in your industry, allow for any material ...
This solution explains when trend analysis is useful in analyzing ratios and whether or not "rules of thumb" are helpful approaches to ratio analysis.