Ratio Analysis

Question

Use the Internet to research an annual report of a retail company.
Then, imagine you are an investor or creditor; suggest the ratios that you believe would provide an investor or creditor with the most important information needed to make accurate predictions about the company’s financial condition. When analyzing a company, is it more important to compare the ratios to competitors or to the company’s previous history?
Provide a rationale for your response.
Note: Students using the online discussion thread must provide a link or instructions to the researched report.

Sample paper

Ratio Analysis

The price/earnings ratio (PE) is one of the most important ratios that can best make predictions about the organization’s financial performance. The PE ratio acts as an absolute way of firm valuation. This is because it values stock as a going concern (Hampton, 2011). The PE ration examines the market price, earnings per share in valuation, and after-tax profits. Earnings per share help in providing an accurate prediction of market activity. The PE ratio is an accurate way of measuring an organization’s performance also because the ratio gives the dollar amount that one needs to invest in the organization in order to earn a dollar in returns of the organization’s earnings.

A creditor or investor may be interested in capital structure ratios, mainly the debt-asset ratio and the debt-equity ratio. Capital structure ratios provide investors with crucial information concerning the organization’s debt and equity components (Hampton, 2011). The ratios help in examining the extent to which the organization’s assets are debt financed. The investor can use the capital structure ratios to know whether an organization has incurred excessive debt that it cannot be able to repay. Likewise, the investor can use the ratios to evaluate the future prospects of the organization and relating to financing. Capital structure ratios are therefore integral to both investors and creditors.

The net profit margin is another ratio that can provide an investor or creditor with key information about an organization. The net profit margin is a ratio that helps evaluate the efficiency of the company in its cost control efforts. A high net profit margin indicates that the organization is efficient in turning revenues into actual profit. Lastly, it is more important to compare ratios to the competitors. The rationale behind this is that it provides an opportunity for the organization to see how it is performing relative to other similar businesses.

Reference

Hampton, J. J. (2011). The AMA Handbook of Financial Risk Management. New York, NY:        AMACOM.

Related:

ACCOUNTING EDUCATION

 

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