1. How do you think financial ratios differ across different industries? Compare two industries of your choice and select a few ratios and explain whether you think the ratios would be higher or lower for each of those industries and explain why.
2. What are some uses and limitations of financial ratios?
1) Financial ratios can differ a lot across different industries due to the way the industry operates. It can and does differ even between companies in the same industry. I have chosen the beverages - soft drink industry and the computer software application industries for comparison.
Current Ratio = (Current Assets) / (Current Liabilities)
I would expect that the Current ratio in the soft drink industry would be high if the company has been in operations for a long time. An example of such a company is Coca-cola. Their equipment has been paid for, and they have few liabilities as they do not need to do much research and development. A company in the computer software application industry, such as Microsoft will have a higher current ratio is it has to continually borrow money to upgrade to the latest computer hardware. Companies in the industry also have to continually conduct research in order keep up with new technology. This would increase their current liabilities.
Debt to Shareholders' Equity Ratio = (Total Liabilities) / (Shareholders' Equity)
I would expect that the soft drink industry would have a low debt to shareholders' equity ratio in the case of a company that has been around for a long time. The reasons are similar to those for the current ratio--namely because they would have low total liabilities since most of the debts have been paid off, ...
This solution explains the differences between financial ratios across institutions, addressing their uses, price earnings and tax rates.
Limitations of Financial Ratio Analysis for Non-Profit Organizations
United Way of Metropolitan Chicago is a nonprofit, tax exempt corporation. Because it receives significant revenue in its annual campaign from large corporations, a recent reform of the board of directors resulted in a majority of directors from the Civic Committee of the Commercial Club that were corporate Presidents. The Civic Committee consists of representatives of large corporations in the area of manufacturing, banking, utilities and business.
The organization attempts to maximize its benefit to the community by minimizing its overhead expenses so that $1 raised in the general campaign results in close to $1 allocated for health and human services. When the board of directors saw that the 13.9% overhead rate for 2005 did not reflect staff costs in the Community Building Division where planning, assessment, monitoring, and evaluation activities are performed, some directors were concerned. They felt that, in the zeal to report a favorable number, the truth was not being told to the community.
Other directors argued that these staff efforts benefit the community in a similar way to the health and human services supported by United Way funding. It was determined that the latter argument was technically correct because of the accounting rules on program related services that apply to nonprofit corporations. The compromise was to report the 13.9% overhead rate with a footnote that 16% was the total overhead rate but that the accounting rules for nonprofits allow the exclusion of program related expenses.
Some of the board members from the nonprofit sector began to discuss other organizational matters that reflect a difference in business and management culture and philosophy. For example, the business sector members rely heavily on financial ratio analysis to understand United Way's financial position in relation to industry standards.
1. What are some of the limitations of financial ratio analysis as a tool for understanding operations that might validate the concern of these board members?
2. List and discuss two factors that limit an organization's ability to replace a depreciated capital asset even if the organization has set aside funds equal to the depreciation schedule for the asset in question.
3. Look at "The Cost of Chronic Disease" slides by Jack Zwanziger, PhD. As Director of the Illinois Department of Public Health, discuss management actions you would initiate to address the implications of this presentation.