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Financial Ratio Essay

1963 words - 8 pages

ISOM 249

Functions and Purposes of Financial Ratios

I. Functions of Financial Ratios

Financial ratios can be used to show a company’s:

• Position in its industry (industry comparisons)
• Accomplishment of objectives (objective comparisons)
• Vulnerability in the economy (time-series/trend analysis)
• Future borrowing power and growth potential (leverage ratios)
• Ability to react to unforeseen external changes (price/earnings ratio)

II. Types of Ratios and Their Purposes

• Profitability ratios indicate how well a company allocates its resources in relation to income generated.
...view middle of the document...

Trend Analysis of ABC Company’s Cost of Goods Sold from 1991-1995

|Year |1991 |1992 |1993 |1994 |1995 |
|$ in thousand |$360,819 |$422,490 |$498,901 |$619,949 |$728,861 |
|Percentage |100% |117.1% |138.3% |171.8% |202% |

The following items are often selected for trend analysis with industry comparisons:

• Sales and other income
• Cost of goods sold
• Marketing, general, and administrative expenses

Calculations and Interpretations of 14 Key Financial Ratios

I. Fourteen Key Financial Ratios

|Profitability Ratios |Return on Sales (Profit Margin) |
| |Return on Assets |
| |Return on Net Worth (Return on Equity) |
|Solvency (Liquidity) Ratios |Quick Ratio |
| |Current Ratio |
| |Current Liabilities to Net Worth |
| |Current Liabilities to Inventory |
| |Total Liabilities to Net worth |
| |Fixed Assets to Net Worth |
|Efficiency Ratios |Collection Period |
| |Sales to Inventory |
| |Assets to Sales |
| |Sales to Net Working Capital |
| |Accounts Payable to Sales |

II. Calculate and Interpret Profitability Ratios

1). Return on Sales (Profit Margin)

Return on Sales (Profit Margin) = Net Profit After Taxes/Annual Net Sales

Interpretation: Return on sales (profit margin) is obtained by dividing net profit after taxes...

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