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Merits of Financial Ratios

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Financial ratios are important to the understanding of the financial health of a company. You and your colleagues work for a financial services firm. Your are discussing the merits of the various financial ratios. Identify four financial ratios and state what they tell you about a firm and why it's important to understand what these ratios mean to both a bank and an investor. Discuss your reasoning regarding these issues in 2-3 paragraphs.

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Solution Summary

The solution discusses the merits of financial ratios for a bank and an investor. Current Ratio, Quick ratio, Days' Receivables Ratio and Inventory Turnover Ratio are discussed.

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Note : Use has been made of material at these sites for answering this question.
http://www.bized.ac.uk
http://edwardlowe.org

1) Current Ratio: The current ratio is a reflection of financial strength. It is the number of times a company's current assets exceed its current liabilities, which is an indication of the solvency of that business.

Current Ratio = Total current assets/Total current liabilities

The current ratio answers the question, "Does the business have enough current assets to meet the payment schedule of current liabilities, with a margin of safety?" A common rule of thumb is that a "good" current ratio is 2 to 1. Of course, the adequacy of a current ratio will depend on the nature of the business and the character of the current assets and current liabilities. There is usually very little uncertainty about the amount of debts that are due, but there can ...

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