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Financial ratios uses and limitations

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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?

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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, ...

Solution Summary

This solution explains the differences between financial ratios across institutions, addressing their uses, price earnings and tax rates.

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