Financial Ratios Essay

563 words - 3 pages

* Choose 4 different financial ratios from your text, course materials, and/or Web resources.
* Answer the following questions:
* What do they tell you about a firm?
* Why is it important for a bank to understand these financial ratios?
* Why is it important for an investor to understand these financial ratios?
* Post a new topic to the Discussion Board that contains your answers to the above questions
Financial ratios are measurements used to analyze entities of financial performance. They are several financial ratios one can choose from, the main four are; profitability ratios, efficiency ratios, liquidity ratios and solvency ratios. Each ratio has different rules and they perform in their own ways. They are important tools that evaluate the profitability, efficiency, liquidity and solvency of an entity of the firm.
Profitability ratios help users of an entity ...view middle of the document...


Efficiency ratios are known as the ratios that measure the effectiveness of management decision making and evaluate turnover and the return on investments (Manley, 2009). Some good examples of efficiency ratios are inventory turnover, sales to receivables and return on assets. Inventory turnover measures the number of times an entire stock of inventory is repurchased; mean while sales to receivables compares trade receivables to revenues. When selling inventory and collecting receivables, a higher number indicates a higher level of efficiency in both situations. When using assets to generate profits, return on assets compares net income before taxes to total assets and helps demonstrate the efficiency of management.
Liquidity ratios help financial statement users evaluate a company ability to meet its current obligations (Manley, 2009). In other words, liquidity ratios evaluate the ability of a company to convert its current assets into cash and pay current obligations. There are two common liquidity ratios; which are the current ratio and the quick ratio. The current ratio is calculated by dividing current assets by current liabilities. And the quick ratio helps determine a company ability to pay obligations that are due as soon as possible.
Solvency also known as the leverage ratios, judge the ability of a company to raise capital and pay its obligations (Manley, 2009). Solvency ratios, which include debt to worth and working capital, decide whether an entity is able to pay all of its debts. In practice, bankers often include leverage ratios as debt covenants in contract agreements. They want to make sure the entity can maintain operations during problematic financial periods.
Financial ratios are used by a range of people such as; bankers, creditors, shareholders and accountants so they can evaluate data presented on entities of financial statements. Bankers and creditors may choose to extend or retract financing and investors may adjust the level of commitment in a company depending on the results of the evaluations.
Reference:
Manley, N. (2009, December). Financial ratios. Retrieved from http://www.stfrancis.edu

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