Paper Ratio and Financial Statement Analysis Essay

Executive SummaryIn bodied finance, both dimension and pecuniary bidding analytic thinking argon important tools that discount be c any in drift to beat out a telephoners strength mo inter dineroaryly. They squirt be use in order to forecast a business prospective hard currency flow and ability to grow in the early, as hearty as a comp anys strengths and weaknesses. Income records, balance sheets, the statement of retain earnings, and the statement of cash flows atomic number 18 the four primary types of monetary statements used in corporate finance. All of these fiscal statements serve to psychoanalyse a fasts cash flows from different perspectives and be all interrelated. dimension abstract, around other important tool in pecuniary compendium, analyzes the probability that a tighten allow be bankable or not.The different kinds of proportions used atomic number 18 liquidity ratios, energy ratios, leverage ratios, profitability ratios, and market- pass judgment indicators, with all(prenominal) type including motley different unique(predicate) ratios that one stack calculate when examining a truehearteds operability. Both the financial statements and ratio analysis passing play an analysis of a self-coloureds finances at a extra phase in period, while besides forecasting its financial perceptual constancy in the prospective. Another advantage is that they allow a potents finance team to comp be its finances to that of other standardized companies, know as benchmarks, in order to measure the strength of their unwaveringly in the marketplace.However, financial statements and ratio analysis back end also lack in their accuracy since financial analysis is a good deal base on historic figures from the past some(prenominal) classs and thus only offer the prospective financial future rather than concrete data since very much(prenominal) a theatres finances are based on the ever-changing marketplace or other fa ctors not in control of the firms managers, much(prenominal) as economic conditions. Despite such disadvantages, financial statements and ratio analysis is a genuinely(prenominal) important aspect in the corporate environment and essential to examining a firms viability. OverviewIn business, financial statements are important tools, which allow a firm to distinctly state its financials in terms of figures, such as tax revenues, expenses, net incomes, and so forth and analyze strengths and shortcomings of the firm. This allows the firms managers to clearly see what is and is not running(a) for the firm. Ratio analysis is used when identifying and analyzing multiple variables in the firms operations, such as inventory, accounts receivable, net staring(a) revenue, etc.When completing financial statement and ratio analysis, it is beneficial for the firm to examine its financial figures over several earlier consecutive years, so that any and all patterns in its operability plu nder be observed and analyzed. such patterns tush reveal aspects of the follow where efficiency is not at its finest and thus at that place is a financial loss. As a result, the company can implement changes in order to emend upon these shortcomings and increase its profits. Ratio analysis is both a qualitative and quantifiable charge of looking at the data in order to analyze how a company functions and ways to improve it by looking at present and previous functioning and forecasting the future of the company.Both financial statement and ratio analysis can provide insight into the success or failures of specialized ingathering lines, allowing managers to make intelligent decisions regarding what their firm should offer in the future to consumers. Financial statement analysis is also a way to assess and validate a companys viability in the marketplace to outside investors/creditors. Financial statements assist managers in understanding how paid their firm is. It is often used to make comparisons of one firm to another(prenominal) or of a specific age period to another time period for the same firm. The main aspects of a financial statement are revenues, expenses, and net income.Revenues are sales song that come from crossings or serve a firm creates through its business operations (Parrino, 2011). For a firm, such as Microsoft, its revenue would come from products such as the computers, phones, tablets, and software it sells to consumers. On the other hand, for a consulting firm, such as Accenture, revenues would antecedent from the fees it charges for its consulting services contracts with confused government agencies around the world. Both companies are providing a product to a consumer, one simply happens to be a tangible product that the great unwashed buy, while the other is a service product that agencies need for their functionality.Expenses are the make ups a firm incurs while generating its revenues (Parrino, 2011). For Microsoft, ex penses would stem from the costs of mental synthesis its products, marketing them, developing new products, shipping them around the world, etc. For Accenture, expenses would stem from the cost of all of its consultants, which embroils their wages, insurance, company laptops it provides to each of them, travel costs for send consultants around the world on projects, etc. Again both types of firms salute expenses some of them are just different. lucre income shows the companys revenue relative to its expenses. If revenues exceeds expenses then(prenominal) the company has a net profit and is in the black for that time period (Parrino, 2011). On the other hand, if expenses exceed revenues then the company has a net loss and is in the red for that time period (Parrino, 2011). By looking at financial statements from one pecuniary period to the next or annually, managers can observe how their firm is progressing. If the numbers show that the firm is not operating at an optimal take aim or there is a sudden decline in profit, managers can delve further into the firms operations using ratio analysis to look for problem areas and address them accordingly.For instance, ratio analysis can allow analysts to view the rate turnover of a specific product line and examine whether something is lacking in that product line that is keep the firms ability to get rid of that inventory to consumers. Such ratio analysis will be elaborated upon later in this paper. There are four types of financial statements income statements, balance sheets, the statement of contain earnings, and the statement of cash flows, which are all vital and interrelated. The income statement calculates the firms net income or its earnings after expenses have been deducted and is used to calculate retained earnings at the end of the year (Parrino, 2011). authorize income is calculated as followed elucidate Income = Revenues ExpensesThe balance sheet summarizes what assets the firm has at a specific point in time, as well as how the firm has financed such assets (Parrino, 2011). contribute assets is calculated as followed summarise Assets = fall Liabilities + Total Stockholders Equity The range of assets will change annually since firms often buy and sell assets, thus altering the firms measure out and financing. Such changes are indicated in thestatement of cash flows, which gives a abstract of changes in the firms balance sheet from the beginning of a period to the end (Parrino, 2011).The statement of retained earnings summarizes changes in the retained earnings in a simpler manner for managers than the statement of cash flows and basically shows the firms expenses and loss from one period to the next (Parrino, 2011). These financial statements can provide a lot of information to managers regarding the operations of the company. If Microsoft sees a decrease in its net income or total assets from one year to the next, this can indicate many things.A decrease in net inco me can indicate whitethornbe some products are not merchandising as well as they have in the past, ungenerousing Microsoft may need to change its marketing strategy or release a new product. A decrease in total assets can mean several things. Perhaps the companys products are of less value than before or perhaps they have fewer liabilities. Deciding what specifically financial statements mean for the future of a firm often requires more than in depth analysis through ratio analysis.Ratio analysis is the use of financial figures to analyze a firms boilersuit operability and evaluate its strengths and weaknesses (Parrino, 2011). It can be used from various perspectives including stockholders, managers, and creditors, in order to evaluate the profitability of a firm. Specifically, a financial ratio is a number from a financial statement that has been scaled by dividing by another financial number in order to show something some the companys operations (Parrino, 2011).There are sever al types of financial ratios liquidity ratios, efficiency ratios, leverage ratios, profitability ratios, and market-value indicators. fluidity ratios focus on whether a firm has the ability to convert current assets into cash pronto without loss of value (Parrino, 2011). Two liquidity ratios are as followed genuine Ratio = Current Assets / Current LiabilitiesQuick Ratio = (Current Assets Inventory) / Current Liabilities Liquidity ratios indicate a firms ability to pay short-term obligations, such as interest payments for debt. This is very important because every firm has creditors, whether its investors, banks, or even tax collectors and even themost profitable company can go under if it is unable to pay all of its obligations for any reason. Efficiency ratios measure how efficiently a firm uses its assets and include the pastimeInventory overturn = Cost of Goods Sold / Inventory eld sales in Inventory = 365 Days / Inventory TurnoverAccounts Receivable Turnover = crystalise gross sales / Accounts ReceivableDays Sales Outstanding = 365 Days / Accounts Receivable TurnoverTotal Asset Turnover = Net Sales / Total AssetsFixed Asset Turnover = Net Sales / Net Fixed AssetsEfficiency ratios are a useful tool in financial analysis because they can examine and identify inefficient use of any kind of asset.For instance, in our case of a decrease net income for Microsoft, financial analysts can look at the inventory turnover for each of its products and analyze whether one is too low indicating that the rate at which they are selling that specific product line is not efficient compared to the cost of producing that product line. Based on this managers can decide whether they should decrease the beat of inventory they produce or cut the product line all together. supplement ratios are used to examine a firms financing or ability to meet long-term financial obligations. Leverage ratios are as followedTotal Debt Ratio = Total Debt / Total AssetsDebt-to-Equity Ratio = Total Debt / Total EquityEquity Multiplier = Total Assets / Total EquityLeverage ratios are important because every firm uses debt or equity and often both for its financing, but the more debt a firm uses, the greater the risk it will default on those debt payments. So, for instance, the total debt ratio can tell you how much debt a firm uses in its hood structure and thus how volatile its earnings are (Parrino, 2011). Profitability ratios measure managements ability to efficiently use the firms assets to generate sales and manage the firms operations (Parrino, 2011) and include the followingGross Profit Margin = (Net Sales Cost of Goods Sold) / Net SalesOperating Profit Margin = EBIT / Net SalesNet Profit Margin = Net Income / Net SalesReturn on Assets(ROA) = Net Income / Total AssetsEBIT ROA = EBIT / Total AssetsReturn on Equity(ROE) = Net Income / Total EquityProfitability ratios are important because they indicate a companys ability to be profitable relative to its expenses . Market-value indicators predict the future of a firms finances using market value trends and financial statements. They includeEarnings Per donation(EPS) = Net Income / manages OutstandingPrice-Earnings Ratio(P/E) = Price Per Share / Earnings Per ShareMarket-to-Book Ratio = Market Value of Equity Per Share / Book Value of Equity per shareMarket-value indicators are important because they can assist in predicting the future for a firm. Whether the firm will be profitable using its current strategy or should it maybe turn to a different strategy to keep up with competing companies. All of these financial ratios are crucial to financial analysis in corporations and used very often by analysts, managers, creditors, stockholders, etc. Advantages and Disadvantages of Ratio AnalysisRatio analysis has several benefits. First, it offers various regularitys of analyzing a companys financial wellbeing, handout beyond just the financial statements by looking at specific aspects of operat ions. This can indicate strengths and shortcomings that managers should be aware of. Improvements can be do in order to increase profitability as a result. For instance, if a Microsoft notices that one product line has a gameyer days sales in inventory than another, this indicates that the specific product stays on the ledge longer and perhaps the firm should focus more on the product line with the lower days sales in inventory as it sells better.Secondly, ratio analysis can assist in predicting earnings or showing a pattern, which managers can use to find the best way to maintain financial profitability. succession financial statements provide numbers such as revenues or expenses, ratio analysis can offer a concrete number describing revenues relative to the cost of the goods sold, such as with the gross profit margin. Such a ratio can indicate how profitable a firms operations were in a specificperiod of time and if very profitable a concrete method of recreating such success.E ssentially, ratio analysis simplifies the information provided in financial statements by compartmentalizing them to show patters and trends, which are very useful. Thirdly, ratio analysis can also be used in order to compare the firms operations to that of its competitors. Often, how well a company is doing depends on the market and how well other companies are doing, so ratio analysis provides a very useful tool to companies in making such comparisons.There are some disadvantages to ratio analysis. Predictions based on ratio analysis can be inaccurate from time to time. This is because ratio analysis is mostly based on historical data from previous time periods, which only offers so much information about the future. Yes, analysts can predict that the market will behave a certain way through market value indicators, but such predictions are only so accurate.The market can be affected by a variety of aspects, such as volatile economic conditions or even a innate disaster. For sho wcase following Hurricane Katrina, at the end of the first week followingU.S. commercial message crude oil inventories fell by 6.4 million barrels from the previous week, indicating a strong market effect on petroleum delinquent to the disaster (Hurricane Katrinas involve, 2011). Businesses cannot control environmental disasters or economic conditions, which is wherefore while ratio analysis is a very useful tool, it cannot forever and a day be relied on 100%. The use of market-value indicators is increasingly used in order to better forecast the future of a firm as it takes into account the economic climate at a specific point in time in order to predict the trend of future financial entities (Niazi, 2011) but again sometimes something like a natural disaster can negatively affect business.This is why having a high operating income and total assets is important to be prepared for such events. While not a perfect model as random economic turbulence can skew results, market-valu e indicators do still provide some insight into the future. Furthermore, when using ratio analysis to compare to another similar benchmark firm, there can also be pitfalls. Often it is unrealistic to find a company similar enough in size, corporate structure, and operations to properly compare to and gauge a market comparison. Thus, often ratio analysis when benchmarking can provide a skewed word picture of where the firmstands against its competitors in the market.Financial statement and ratio analysis are very useful in corporate finance that provide much information to analysts, managers, stockholders, and creditors about the financial state of a firm. While there are some shortcomings to ratio analysis, its advantages in practice surely outperform its disadvantages and offer valuable tools to cultivate a thriving company.ReferencesHurricane Katrinas impact on the U.S. oil and natural gas markets. (2011, September 12). Retrieved from http//www.eia.gov/oog/special/eia1_katrina_ 091205.htmlNiazi, G. S. K., Hunjra, A. I., Rashid , M., Akbar, S. W., & Akhtar, M. N. (2011). Practices of running(a) capital policy and performance assessment financial ratios and their relationship with cheek performance. World Applied Sciences Journal, 12(11), 1967-1973.Parino, R., Kidwell, D. S. & Bates, T. W. (2012). Fundamentals of Corporate Finance Second edition. bath Wiley & Sons Hoboken, NJ.