Financial Metrics and Ratios



Financial Metrics and Ratios

Introduction

Basically, ratios are tools to help the analyst, investors or shareholders to analyze the performance and condition of the business. The variable used by prior researchers computed from income statement and balance sheet items. This is due to the information easily can get from the published annual reports. But, the used of ratios in business should take into consideration of economic situation and also the business condition whether the business just started the operation, achieving the business growth or achieved the maturity. In addition, the ratio also would be different from one industry to other industry.(Kaplan,1984)

Lately, there are many issues in accounting irregularities and that result in corporate failure. The collapse of Enron and WorldCom in US, had given big impact to many group and attract the attention of many parties. In Malaysia, the financial scandal of Transmile Group Bhd in year 2007 also creates attention as well as increasing the numbers of analyst including the creditors and banker officers. In other way, the analysts will use ratio analysis and best decision making in prediction of the probability of the corporate failure or performance.Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company (Investopedia). Ratio analysis been used as basic analysis by business Managers,Investors, government regulators (including stakeholders) in prediction the performance of the company. (Scapens,1990)

Discussion

Ratios used to analyze Balance sheet and Income Statement

Fundamentally, the models or tools are been used to predict the business failure are ratios as well as intelligent and ability decision making. Otley et al, (1990) emphasizes two important ways why the stakeholders (consist of shareholders, lenders, suppliers, clients and government) to predict the business failure. Firstly, as a 'signal' to them and take corrective action in preventing the business failure. They can take immediate action and able to continue the business operation with better management. Secondly, it is useful to them in decision making process. These models would help them such as in acquiring another company or when they want to invest in. Furthermore, the creditors and investors will more likely be interested in a company that has sound financial planning and future benefit performance rather than failure in next couple of years.

Kaplan (1984), evaluated the accounting ratios and the ability of bank officers in conjunction with business failure prediction. He found that the selected accounting ratios are very useful in determining reliable prediction of business failure. In today's environment, the bank officers are more rigid and strict in giving loan to the companies which do not meet their certain percentage or requirement standard. The bank officers will look out the company's profitability and leverage. They want to know whether the company has the ability to pay back the amount (loan) including the interest in specific time.(Kaplan,1984)

There are various variables that can be used to predict the corporate failure. Different researchers selected different financial ratios and Kaplan (1984) used five variables ...