Using Financial Ratios when Analyzing Financial Statements
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Scenario:
You are the manager of the high school athletic team division of Abel Athletics, a manufacturer of athletic equipment and apparel, which has recently gone through the initial public offering (IPO) process and has become a public company. Abel Athletics has annual sales revenue of approximately $50 million and makes seven unique and distinct products (which serve seven different markets). Each product is represented by its own division within the company and has its own group of sales, marketing, and manufacturing personnel. Some departments, including human resources and the finance division, support the entire organization. Operations consist of a single headquarters and production (manufacturing) center.
In your role as division manager you are responsible for compiling and reporting on budget / forecast data, for using financial information in decision making, and for assessing and valuing new business opportunities (which will ultimately be presented to upper management). You report directly to the Plant Manager; however, you work closely with the Chief Financial Officer (CFO) and the accounting department's staff accountants assist you with your budget / forecast responsibilities.
You have been informed by the CFO that Abel Athletics will be aggressively pursuing new business opportunities, which may include expansion through acquisition and the development and implementation of new products. As a publicly traded company, Abel Athletics is scrutinized by bankers and investors as never before. In fulfilling your responsibilities you must keep this in mind, and you must instill a new sense of financial discipline in the organization.
Task:
You have been given the financial statements and asked to analyze the financial performance of your division. Other managers have suggested you use financial ratios in your analysis. What are financial ratios? Which ratios might you use in your analysis? List them and explain what information they provide. How would you use them to make managerial decisions?
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Accounting is the means by which information about an enterprise is communicated and, thus, is sometimes called the language of business. Costs, prices, sales volume, profits, and return on investment are all accounting measurements.
Financial Statements is designed primarily to assist investors and creditors in deciding where to place their scarce investment resources. It is also used to help management to know the performance of organization.
Financial statements are useful tools for evaluating both profitability and liquidity. Used separately, or in combination, the income statement and balance sheet help interested parties to measure a company's current financial performance, and to forecast its profit and cash flow potential.
In financial analysis, we need qualitative information and try to read between the numbers. We have to ask all the right questions. Over the years, there are some ratios, which have become more popular and handy for rule of thumb analysis of financial statements. Our purpose in this note is not deride them but to advice the reader to use them properly to derive the correct results.
Ratio analysis can also help us to check whether a business is doing better this year than it was last year; and it can tell us if our business is doing better or worse than other businesses doing and selling the same things. In other words it helps in inter firm and intra firm comparison.
We can use ...
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