Paper Ratio and Financial Statement Analysis Essay

Executive digestIn corporate finance, both dimension and fiscal avouchment abstract argon all-important(a) tools that sack be utilise in effect to assess a lodges strength fiscally. They buns be employ in influence to forecast a business prospective cash blend and ability to grow in the approaching, as well as a companys strengths and weaknesses. Income conjure upments, respite sheets, the statement of carry mesh, and the statement of cash flows argon the four primary types of financial statements used in corporate finance. All of these financial statements serve to tin canvass a unswervings cash flows from contrary perspectives and atomic number 18 all interrelated. symmetry analytic thinking, an opposite(prenominal) important tool in financial psycho psychoanalysis, analyzes the probability that a squiffy willing be lucrative or not.The disparate kinds of ratios used are liquidity ratios, ability ratios, leverage ratios, profitability ratios, and foodstuff- revalue indicators, with each type including various different particular proposition ratios that one female genitals play when examining a dissipateds operability. Both the financial statements and ratio analysis offer an analysis of a firms finance at a particular point in time, while similarly forecasting its financial stability in the future. Another advantage is that they allow a firms finance team to equate its finances to that of other similar companies, known as benchmarks, in order to value the strength of their firm in the market.However, financial statements and ratio analysis stool also lose in their accuracy since financial analysis is often based on historical figures from the past some(prenominal) years and thus only offer the prospective financial future rather than concrete information since often a firms finances are based on the ever-changing marketplace or other factors not in control of the firms wanglers, much(prenominal) as scotch con ditions. Despite such disadvantages, financial statements and ratio analysis is a rattling important aspect in the corporate environment and essential to examining a firms viability. Over cipherIn business, financial statements are important tools, which allow a firm to clearly state its financials in terms of figures, such as revenues, expenses, exonerate incomes, etc. and analyze strengths and shortcomings of the firm. This allows the firms managers to clearly see what is and is not working for the firm. Ratio analysis is used when identifying and analyzing multiple variables in the firms trading operations, such as inventory, accounts receivable, dismiss sales, etc.When complemental financial statement and ratio analysis, it is beneficial for the firm to examine its financial figures over some(prenominal) introductory consecutive years, so that any and all patterns in its operability can be observed and analyzed. such patterns can reveal aspects of the company where effi ciency is not at its finest and thus there is a financial waiver. As a result, the company can implement exchanges in order to improve upon these shortcomings and increase its profits. Ratio analysis is both a qualitative and quantitative way of looking at the entropy in order to analyze how a company functions and ways to improve it by looking at present and preceding functioning and forecasting the future of the company.Both financial statement and ratio analysis can go out insight into the success or failures of specific carrefour simple eyes, allowing managers to make intelligent decisions regarding what their firm should offer in the future to consumers. Financial statement analysis is also a way to assess and validate a companys viability in the marketplace to outside investors/creditors. Financial statements assist managers in understanding how profitable their firm is. It is often used to make comparisons of one firm to another or of a specific time period to another time period for the same firm. The main aspects of a financial statement are revenues, expenses, and net income.Revenues are sales add up that come from products or services a firm creates through its business operations (Parrino, 2011). For a firm, such as Microsoft, its revenue would come from products such as the computers, phones, tablets, and software it sells to consumers. On the other hand, for a consulting firm, such as Accenture, revenues would stem from the fees it charges for its consulting services contracts with various presidential term agencies around the world. Both companies are providing a product to a consumer, one simply happens to be a tangible product that people buy, while the other is a service product that agencies bespeak for their functionality.Expenses are the be a firm incurs while generating its revenues (Parrino, 2011). For Microsoft, expenses would stem from the costs of building its products, marketing them, developing raw(a) products, shipping them around the world, etc. For Accenture, expenses would stem from the cost of all of its consultants, which includes their wages, insurance, company laptops it provides to each of them, travel costs for sending consultants around the world on projects, etc. Again both types of firms exhibit expenses some of them are just different.Net income shows the companys revenue relative to its expenses. If revenues exceeds expenses then the company has a net profit and is in the black for that time period (Parrino, 2011). On the other hand, if expenses exceed revenues then the company has a net loss and is in the red for that time period (Parrino, 2011). By looking at financial statements from one fiscal period to the next or annually, managers can observe how their firm is progressing. If the numbers show that the firm is not operating at an optimal level or there is a sudden dec debate in profit, managers can delve further into the firms operations utilize ratio analysis to look for prob lem areas and address them accordingly.For instance, ratio analysis can allow analysts to view the rate turnover of a specific product line and examine whether something is lacking in that product line that is hindering the firms ability to get rid of that inventory to consumers. Such ratio analysis will be elaborated upon later in this paper. in that respect are four types of financial statements income statements, commensurateness sheets, the statement of retained earnings, and the statement of cash flows, which are all vital and interrelated. The income statement calculates the firms net income or its earnings after expenses have been deducted and is used to calculate retained earnings at the end of the year (Parrino, 2011). Net income is calculated as followedNet Income = Revenues ExpensesThe balance sheet summarizes what assets the firm has at a specific point in time, as well as how the firm has financed such assets (Parrino, 2011). intrinsic assets is calculated as follo wed kernel Assets = Total Liabilities + Total Stockholders virtue The value of assets will change annually since firms often buy and sell assets, thus altering the firms value and financing. Such changes are referd in thestatement of cash flows, which gives a summary of changes in the firms balance sheet from the beginning of a period to the end (Parrino, 2011).The statement of retained earnings summarizes changes in the retained earnings in a simpler manner for managers than the statement of cash flows and basically shows the firms expenses and loss from one period to the next (Parrino, 2011). These financial statements can provide a lot of information to managers regarding the operations of the company. If Microsoft sees a decrease in its net income or total assets from one year to the next, this can indicate many things.A decrease in net income can indicate maybe some products are not selling as well as they have in the past, meaning Microsoft may need to change its marketing s trategy or release a new product. A decrease in total assets can mean several things. Perhaps the companys products are of less value than before or perhaps they have fewer liabilities. Deciding what specifically financial statements mean for the future of a firm often requires more in depth analysis through ratio analysis.Ratio analysis is the use of financial figures to analyze a firms overall operability and evaluate its strengths and weaknesses (Parrino, 2011). It can be used from various perspectives including stockholders, managers, and creditors, in order to evaluate the profitability of a firm. Specifically, a financial ratio is a number from a financial statement that has been scaled by dividing by another financial number in order to show something about the companys operations (Parrino, 2011).There are several types of financial ratios liquidity ratios, efficiency ratios, leverage ratios, profitability ratios, and market-value indicators. Liquidity ratios focus on whether a firm has the ability to convert current assets into cash quickly without loss of value (Parrino, 2011). deuce liquidity ratios are as followed actual Ratio = Current Assets / Current LiabilitiesQuick Ratio = (Current Assets Inventory) / Current Liabilities Liquidity ratios indicate a firms ability to pay short-term obligations, such as interest payments for debt. This is very important because any firm has creditors, whether its investors, banks, or even tax collectors and even themost profitable company can go under if it is unable to pay all of its obligations for any reason. dexterity ratios circular how efficiently a firm uses its assets and include the chaseInventory disturbance = greet of Goods change / InventoryDays vernacular sales in Inventory = 365 Days / Inventory TurnoverAccounts Receivable Turnover = Net Sales / Accounts ReceivableDays Sales Outstanding = 365 Days / Accounts Receivable TurnoverTotal Asset Turnover = Net Sales / Total AssetsFixed Asset Turno ver = Net Sales / Net Fixed AssetsEfficiency ratios are a useful tool in financial analysis because they can examine and identify inefficient use of any kind of asset.For instance, in our case of a decrease net income for Microsoft, financial analysts can look at the inventory turnover for each of its products and analyze whether one is too low indicating that the rate at which they are selling that specific product line is not efficient compared to the cost of producing that product line. Based on this managers can decide whether they should decrease the core of inventory they produce or cut the product line all together. Leverage ratios are used to examine a firms financing or ability to meet long-term financial obligations. Leverage ratios are as followedTotal Debt Ratio = Total Debt / Total AssetsDebt-to-Equity Ratio = Total Debt / Total EquityEquity Multiplier = Total Assets / Total EquityLeverage ratios are important because every firm uses debt or equity and often both for i ts financing, but the more debt a firm uses, the greater the risk it will default on those debt payments. So, for instance, the total debt ratio can tell you how much debt a firm uses in its capital structure and thus how volatile its earnings are (Parrino, 2011). Profitability ratios measure managements ability to efficiently use the firms assets to generate sales and manage the firms operations (Parrino, 2011) and include the followingGross Profit coast = (Net Sales Cost of Goods Sold) / Net SalesOperating Profit Margin = EBIT / Net SalesNet Profit Margin = Net Income / Net SalesReturn on Assets(ROA) = Net Income / Total AssetsEBIT ROA = EBIT / Total AssetsReturn on Equity(ROE) = Net Income / Total EquityProfitability ratios are important because they indicate a companys ability to be profitable relative to its expenses. Market-value indicators figure the future of a firms finances using market value trends and financial statements. They includeEarnings Per piece of land(EPS) = Net Income / Shares OutstandingPrice-Earnings Ratio(P/E) = Price Per Share / Earnings Per ShareMarket-to-Book Ratio = Market Value of Equity Per Share / Book Value of Equity per shareMarket-value indicators are important because they can assist in predicting the future for a firm. Whether the firm will be profitable using its current strategy or should it maybe switch to a different strategy to keep up with competing companies. All of these financial ratios are crucial to financial analysis in corporations and used very often by analysts, managers, creditors, stockholders, etc. Advantages and Disadvantages of Ratio AnalysisRatio analysis has several benefits. First, it offers various methods of analyzing a companys financial wellbeing, going beyond just the financial statements by looking at specific aspects of operations. This can indicate strengths and shortcomings that managers should be aware of. Improvements can be make in order to increase profitability as a result. For inst ance, if a Microsoft notices that one product line has a higher days sales in inventory than another, this indicates that the specific product stays on the shelf longer and perhaps the firm should focus more on the product line with the commence days sales in inventory as it sells better.Secondly, ratio analysis can assist in predicting earnings or showing a pattern, which managers can use to find the best way to swan financial profitability. While financial statements provide numbers such as revenues or expenses, ratio analysis can offer a concrete number describing revenues relative to the cost of the goods sold, such as with the gross profit margin. Such a ratio can indicate how profitable a firms operations were in a specificperiod of time and if very profitable a concrete method of recreating such success.Essentially, ratio analysis simplifies the information provided in financial statements by compartmentalizing them to show patters and trends, which are very useful. Thirdly , ratio analysis can also be used in order to compare the firms operations to that of its competitors. oftentimes, how well a company is doing depends on the market and how well other companies are doing, so ratio analysis provides a very useful tool to companies in devising such comparisons.There are some disadvantages to ratio analysis. Predictions based on ratio analysis can be inaccurate from time to time. This is because ratio analysis is mostly based on historical data from previous time periods, which only offers so much information about the future. Yes, analysts can predict that the market will behave a certain way through market value indicators, but such predictions are only so accurate.The market can be affected by a transformation of aspects, such as volatile stintingal conditions or even a natural mishap. For example following Hurricane Katrina, at the end of the first week followingU.S. commercial crude oil inventories fell by 6.4 million barrels from the previou s week, indicating a strong market effect on petroleum overdue to the disaster (Hurricane Katrinas impact, 2011). Businesses cannot control environmental disasters or economic conditions, which is why while ratio analysis is a very useful tool, it cannot always be relied on 100%. The use of market-value indicators is increasingly used in order to better forecast the future of a firm as it takes into account the economic climate at a specific point in time in order to predict the trend of future financial entities (Niazi, 2011) but again sometimes something like a natural disaster can negatively affect business.This is why having a high operating income and total assets is important to be prepared for such events. While not a perfect model as random economic turbulence can skew results, market-value indicators do still provide some insight into the future. Furthermore, when using ratio analysis to compare to another similar benchmark firm, there can also be pitfalls. Often it is imp ossible to find a company similar enough in size, corporate structure, and operations to flop compare to and gauge a market comparison. Thus, often ratio analysis when benchmarking can provide a skewed impression of where the firmstands against its competitors in the market.Financial statement and ratio analysis are very useful in corporate finance that provide much information to analysts, managers, stockholders, and creditors about the financial state of a firm. While there are some shortcomings to ratio analysis, its advantages in practice surely surpass its disadvantages and offer valuable tools to cultivate a thriving company.ReferencesHurricane Katrinas impact on the U.S. oil and natural gas markets. (2011, September 12). Retrieved from http//www.eia.gov/oog/special/eia1_katrina_091205.htmlNiazi, G. S. K., Hunjra, A. I., Rashid , M., Akbar, S. W., & Akhtar, M. N. (2011). Practices of working capital policy and performance assessment financial ratios and their race with orga nization performance. World Applied Sciences Journal, 12(11), 1967-1973.Parino, R., Kidwell, D. S. & Bates, T. W. (2012). Fundamentals of Corporate Finance Second edition. John Wiley & Sons Hoboken, NJ.