LIQUIDITY ANALYSIS Liquidity ratios are the ratios that measure the ability of a company to meet its short term debt obligations. These ratios measure the ability of a company to pay off its short-term liabilities when they fall due. The liquidity ratios are a result of dividing cash and other liquid assets by the short term borrowings and current liabilities. They show the number of times the short term debt obligations are covered by the cash and liquid assets. If the value is greater than I, it means the short term obligations are fully covered.
The objective of ratio analysis is to judge the earning capacity,financial soudness and operating efficiency of an business organization. The use of ratio in financial management analysis helps the management to know the profitability,financial position (liquidity and solvency) and operating efficiency of an enterprise. There are various advantages derived by the use of accounting ratios. It simplifies, summarizes and systematizes a long array of accounting figures to make them understandable. It is also useful for diagnosis of the financial health of an enterprise.
This ratio analysis can be used to assess financial strength and weakness of a business as well as a platform to make financial decisions. It can also use for budgetary, future planning and comparison purposes. Once the financial ratios been calculated, non-finance background people including stakeholders, lenders, management, and investors will be able to comfortably mingle with finance statistics as it will highlight the necessary information of the company rather than go through the whole financial report. According to Fraser and Ormiston (2004) financial analysis can be categorized by four types of ratios which are liquidity ratio, profitability ratio, efficiency ratio and leverage ratios. However, despite the advantages of ratio analysis, certain limitations will make it less meaningful.
Analysis of financial statements is useful in making a decision whether to grant or extend credit to a customer. 3. It is useful in deciding how much portion of the profit is to be distributed as dividend and how much portion will you want to retain? 4. It helps in assessing the future growth potential of the firm.
Under this type of analysis, a number of ratios used for measuring the meaningful quantitative relationship between the items of financial statements during the particular period. This type of analysis is useful in comparing the performance, efficiency, and profitability of several companies in the same group or divisions in the same company. In order to avoid the limitations of Comparative Statement, this type of analysis is designed. Under this method, financial statements are analyzed to measure the relationship of various figures with some common base. Accordingly, while preparing the Common Size income statement, total sales is taken as a common base and other items are expressed as a percentage of sales.
Solvency Ratios This ratio used to measure the company’s ability to pay its debt indicates The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations. • Debt to Equity = Total debt Total equity AVON= -4.5 ULTA= .65 REVLON= -5.9 This ratio represent the financial efficiency being used by the company and including both short term and long term debt. A Debt to Equity ratio of 2 indicates that the company gets two-thirds of its capital financing from debt and one-third from shareholder equity, so it borrows twice funding as it owns, this ratio as benchmark shouldn’t be more than 2 to avoid higher interest expense, and in some cases could affect the company credit score. • Debt to assets = Total debt Total assets This ratio indicate that the company gets all its capital finance from debt with negative equity This ratio is comparing between the total debt and the total assets to show the company’s ability to cover its debt using its assets, ratio greater than 1 shows that a big portion of debt is funded by assets, which means, the company has more liabilities than assets AVON= = 1.12 ULTA= .39 REVLON= 1.2 Avon products company has debt more than its
Financial Ratio Analysis - Definition, Purpose, Advantages, and Disadvantages Firstname Lastname Institutional Affiliation Financial Ratio Analysis - Definition, Purpose, Advantages, and Disadvantages Meaning of Financial Ratios: Financial Ratios are essential quantitative financial tools that are comprehensively used by financial experts to analyze a company’s financial performance such as business evaluation, fundamental analysis, business analysis, etc. In financial ratio analysis, an expert uses ratio to study various financial parameters from a company’s financial statements such as income statement, balance sheet etc., for efficient and effect decision making. Some of the financial ratios are listed below for
The cash ratio is the number of times that the company could meet its current obligations to its current cash balances. The higher the reserve ratio, the more likely a company will be able to pay its short-term debt. Shortly before failure, companies often have very low cash reserve ratio, low levels of inventories, receivables and relatively low current high ratios. Therefore, analyze that Bayou is lays on which position (Henderson et al.,
nterpreting 'Receivables Turnover Ratio' A high receivables turnover ratio can imply a variety of things about a company. It may suggest that a company operates on a cash basis, for example. It may also indicate that the company’s collection of accounts receivable is efficient, and that the company has a high proportion of quality customers that pay off their debts quickly. A high ratio can also suggest that the company has a conservative policy regarding its extension of credit. This can often be a good thing, as this filters out customers who may be more likely to take a long time in paying their debts.
It measures the ability of the company to pay their current liabilities with their current assets. By this ratio, it also measures the liquidity of the company and bank is interested in this ratio. ABC Company is not doing well as their working capital is too low and will