2 pages/≈550 words
Literature & Language
Management: Financial Ratios (Essay Sample)
Discuss the different financial ratios that we use in Financial Management. What are the limitations of financial ratios? How do we overcome these limitations? Include some real world examples in your discussion source..
Financial ratios compare two measurements and can be grouped into different categories depending on how they are risk bearing, but they must facilitate decision-making as well as provide effective information (Megginson & Smart, 2009).
Liquidity indicators: This show the ability of the firm to meet financial obligations as they fall due, when business operations also not disrupted. These include the current ratio and working capital, both calculated from the balance sheet.
Solvency indicators/ debt ratios: This shows the obligations and amount of debt in a business relative to that of equity. The indicators depict a business’s ability to meet her obligations if all assets were sold. They include the Debt/ Asset Ratio, Equity/ Asset Ratio and Debt /Equity Ratio.
Profitability indicators: This indicates the level that a business generates profit from the use of capital, land, labor, and management. These indicators are calculated from the income statement and balance sheet, they are Operating Profit Margin ratio, Rate of return on Equity, Rate of Return on Assets and Net Income on Assets.
Financial Efficiency / Activity / performance ratios: This indicates how a business uses asset to maintain efficiency in the operations of a business. These include, the asset turnover ratio, stock turnover ratio and the debtor days ratio.
Market value indicator: These ratios depict the value of a business through use of market data rather than use of historical data. The price/ earnings (P/E) ratio is the most quoted indicator, there is also the market/book (M/B) ratio which gives information on how investors see a business’s past and future performance.
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