Use of ratio in analyzing financial statements



Use of ratio in analyzing financial statements

Benefits of using ratios in analyzing financial statement

Ratio analysis is being viewed as very valuable technique for analyzing the financial position of the company, and is very useful in analyzing the performance of the company with is competitors, and within the industry. In addition to this, some of the primary benefits of using ratio analysis for company are described below (Chesnick, 2000).

Ratio analysis is extremely useful for the company in decision-making process, as financial statement of company comprises of raw information, but does not help manager in identifying detail facts, however, with the help of ratio a financial team can identify the roots of its financial data. For example, current ration of the company is 2:1, whereas industry current ratio is 1:2, this indicates, that current ratio of the company is high, and management can take steps to bring it to the level of industry average.

Secondly, financial ratios are helpful in identifying the weak and strength point of the company. Thirdly, financial ratio are helpful in forecasting, and planning for future, for instance, company average inventory turnover for five year period are 45, 50, 45, 55, 60. This shows that company on average take one and half month to sell and replace old inventory with new inventory, with this, management of the company can draft a plan for reducing the inventory turnover period (Friedlob & Schleifer, 2003). In addition to this, ratio analysis is useful in communication, in controlling the investment decision of company, in dealing with shareholders, and others.

Two key ration for analyzing Target Corporation

Current ratio, and profit margin ratio has been finalized to analyze the performance of target corporation. Current ratio has been selected because it would help in determining the financial strength of the target corporation, such as its ability of paying of its short term debt with current assets, and maintaining enough scope of bearing small amount of loss (Harrington, 2005). Secondly, profit margin ratio is selected because it would provide the clear profitability company is earning from it sales, it is also useful in identifying the amount of income tax payment, in paying off debt amount and others. Moreover, this ratio will enable company to compare the performance of sales with preceding year, and with sales of substitute products.



Financial statement and formula for calculating the selected ratio

Data for the calculation of current ratio would be taken from balance sheet, and current ratio is calculated using the following formula

Current ratio: Total current assets/total current liabilities

On the other hand, data for the calculation would be taken from the income statement of the company, and would be calculated with following formulate

Net profit margin ratio = Net profit before tax/Net sales



Comparing the calculated ratio with industry ratio

Ratio

Target corp.

Industry ratio

Current ratio

1.2

1.5

Profit margin ratio

30.38 %

30.38%

Current ratio of target corp. is below the level of industry ration, which indicates that company's performance is better than of average industry performance, and it is financial strong with the capability of ...