Calculating financial ratios and interpreting
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Using the sample financial statements, calculate the financial ratios and then interpret those results against historical data and industry benchmarks.
Write a 350- to 700-word summary of your analysis.
Show financial calculations where appropriate.
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Solution Summary
A primer on several financial ratios, including how to calculate, and how to interpret the results of the analysis by relating the solution to the impacts on the business.
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OK, here goes:
There are loosely 5 categories of ratios to consider:
* Liquidity
* Efficiency
* Leverage
* Profitability
* Market Value
When we calculate ratios, we are trying to gain a common size in order to compare data for two reasons:
first, we are trying to compare our performance to that of our competitors (using industry averages);
second, we are trying to compare our current performance to past performance to identify strengths and weaknesses.
So let's review each category along with how to calculate each ratio:
LIQUIDITY ratios deal with the solvency of the corporation --- do they have enough cash on hand to pay bills and to continue operating?
It is calculated by dividing Current Assets/Current Liabilities = Total current assets/total current liabilities. Generally any value obtained greater than one means that the firm can pay its current bills, and have something in the form of cash left over. The question is: Is it an improvement over past performance, and is it the same as or better than the ratio set forth by the industry in general?
There is also a quick ratio which is identical to the one mentioned above, but it excludes inventory from its calculation because inventory will take the longest to liquidate.
EFFICIENCY ratios deal with our ability to manage inventory and the ability to collect for credit sales.These are also referred to as ACTIVITY ratios, and deal with collections as well as inventory turnover.
When we sell through our inventory, we create accounts receivable which, when collected, leads to the cash flow necessary to pay bills and sustain the firm. Now we are interested in the efficiency of collecting for credit sales, measured by:
Receivables Turnover = Total operating ...
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