Intro. to Financial Ratios (20.1)

Question 1

What are ratios useful for?

Answer 1

Ratios are useful tools for expressing relationships among data that can be used for internal comparisons and comparisons across firms. They are often most useful in identifying questions that need to be answered, rather than answering questions directly. Specifically, ratios can be used to do the following:

Project future earnings and cash flow.
Evaluate a firm's flexibility (the ability to grow and meet obligations even when unexpected circumstances arise).
Assess management's performance.
Evaluate changes in the firm and industry over time.
Compare the firm with industry competitors.

Question 2

What are the limitations of using financial ratios

Answer 2

Analysts must also be aware of the limitations of ratios, including the following:

Financial ratios are not useful when viewed in isolation. They are only informative when compared to those of other firms or to the company's historical performance.
Comparisons with other companies are made more difficult by different accounting treatments. This is particularly important when comparing U.S. firms to non-U.S. firms.
It is difficult to find comparable industry ratios when analyzing companies that operate in multiple industries.
Conclusions cannot be made by calculating a single ratio. All ratios must be viewed relative to one another.
Determining the target or comparison value for a ratio is difficult, requiring some range of acceptable values.

Question 3

What are some of the best ways to analyze a company using graphs? (best types of charts/graphs)?

Answer 3

A stacked column graph (also called a stacked bar graph) shows the changes in items from year to year.

Line Graph presents the same data as Stacked Column (Stacked Bar) Graph , but as a line graph.

Regression analysis can be used to identify relationships between variables. The results are often used for forecasting.