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CHAPTER 3: FINANCIAL RATIO & ANALYSIS - Coggle Diagram
CHAPTER 3: FINANCIAL RATIO & ANALYSIS
FINANCIAL RATIOS
:moneybag: An important analysis tool to analyze a firm's financial performance at a point of time and over certain period of time.
:moneybag: able to tell whether the company's financial standing and condition is in good health or otherwise.
:moneybag: Main sources of information are financial statements
:moneybag: Interested parties: shareholders (investors), creditors, managers, prospects investors, regulatory bodies, employees
TYPE OF RATIOS COMPARISON
Vertical or Trend or Time-Series Analysis:
:moneybag: Used to evaluate a firm’s performance over time (year to year).
Horizontal or Comparative or Cross-Sectional Analysis
:moneybag: Used to compare different firms at the same point in time.
:moneybag: Industry comparative analysis
Combined Analysis
:moneybag: Combined analysis simply uses a combination of both time-series analysis and cross-sectional analysis
TYPES OF FINANCIAL RATIOS
Liquidity Ratios
measure the ability of a firm to meet maturing liabilities by relying on current assets (i.e. how liquid the firms to meet short-term obligation).
Asset Management or Activity Ratios or Efficiency Ratios
measure effectiveness of a firm in using its resources or assets
Leverage or Debt Ratios
measure the extent to which a firm had been financed by debt
Profitability Ratios
measure the profitability of the firm
Market Ratios
measures the ability of the company to generate market value in excess of its investment costs
LIMITATIONS OF FINANCIAL RATIOS
Unreliable Figures
:moneybag: The practice of "window dressing" may result in hypothetical figures so that the company will look good in the eyes the investors.
Different Accounting Treatments
:moneybag: There are certain items in the financial statements are not consistent from one firm to another due to differences in accounting system (e.g., LIFO or FIFO in inventories management).
Non-Comparative Data
:moneybag: Sometimes it is difficult to classify industry for comparison as a result of the diversification practiced by many companies in the market place.
Benchmark on average index
:moneybag: Industry averages are just average. Comparison should actually be done with above average industry.