2.12 Financial Ratios

Question 1

How do we use financial ratios?

Answer 1

• given similar sizes of to companies or more, we can make COMPARISONS
• the financial performance between companies
  e. g. comparing share prices (ratios are used) => are shares over priced or under priced?

Question 2

What does high current ratio mean?

Answer 2

• indicates high liquidity

- may also indicate inefficient use of cash

Question 3

What does total debt ratio indicate?

Answer 3

• addresses firm’s long-run ability to meet obligations

- also indicates FINANCIAL LEVERAGE

Question 4

What does profit margin indicate?

Answer 4

• tells us how much profit we’re making for every dollar in sales
• high profit margin desirable

Question 5

What does return on assets indicate?

Answer 5

• measure of profit per dollar per assets

Question 6

What does return on equity indicate?

Answer 6

• Measure of how shareholders performed during the year

- true-bottom-line measure of performance (due to primary goal of firm)

Question 7

What does earnings per share indicate?

Answer 7

• market value measure

Question 8

What does the price earning ratio indicate?

Answer 8

• it is a measure of how much investors are willing to pay per dollar

Question 9

What does pay out ratio indicate?

Answer 9

• what company may be doing with their earnings