Financial Analysis and Management



Financial Analysis and Management

1. What is the 'pyramid of ratios' and how useful is it in interpreting financial statements?

Pyramid of Ratios, also known as Du Pont- Pyramid of Ratios is a matrix of ratios that help evaluate company's financial statement and evaluate its sustainability. Du Pont analysis enables enterprise profitability study using publicly available data from the profit and loss account and the balance sheet. Through this analysis, using simple techniques, one can to understand the profitability of the company significantly greater depth than when using only a standard ratio analysis. Du Pont analysis shows which elements affect the company's financial structure and how (Peterson et al, 2004). The pyramid is beneficial to compare the company with that of the rivals to understand how the situation is as against the industry. This comparison allows spotting the positive and negative effects and offers various options for increasing return on equity through the manipulation of individual elements that affect profitability.

2. Discuss the usefulness of the following key investor ratios in understanding the performance of a business?

Dividend Rate

The dividend is the part of the profit which a corporation pays to its shareholders or a cooperative pays out to its members. The amount of the dividend often reflects on profits of the company which is usually a part of the profit retained and the reserves are supplied. The rate of dividend as well as its frequency is an indicator of firms' performance. Dividend payment shows that firm is getting enough profitability and it attracts investment and sets positive grounds for lenders.

Dividend Yield

Dividend Yield is the ratio of the annual dividend on the share to the share price. This value is expressed most often as a percentage. The higher this ratio, the greater the income from invested capital is achieved by the shareholder. Too high a value of this index, however signifies overeating' profits which may reduce the company's investment opportunities. This indicator is specifically important for the long-term investors (Shim et al, 2000).

Earnings Per Share

Earnings Per Share is the ratio of net profit of the company available for distribution to the annual average number of ordinary shares. It is a measure for assessing the performance of a public company. It is one of the key indicators used to compare the investment attractiveness and efficiency of companies operating in the stock market. International Financial Reporting Standards IAS / IFRS and US-GAAP define the methodology of calculating earnings per share and set the requirements for publication of this indicator in the annual accounts (Shim et al, 2000). The importance of this indicator lies in the fact that it is used to compare the investment attractiveness and effectiveness. It tells how much profit the business earned out of invested capital. This indicator is used for businesses that are categorized as a public company which issues its shares on the stock exchange. The size of this ratio indicates the importance of the capital market.

P/E Ratio

Price to Earnings ratio is a measure for the evaluation of ...