Ratio and Financial Statement Analysis Essay

This paper analyzes tools phthisisd in financial outline such as ratios. Financial ratio abridgment is a judicious way for different stakeholders to use for different goals.This paper demonstrates that financial ratio analysis is an important legal instrument to estimate resources and their used. It also demonstrates that despite the fact that financial ratio analysis is an excellent tool, it does deem constraints. In fact, we will examine financial ratio by analyzing they limitations and they benefits.References used in this paper ar from books and journal in a scholarly journal. Presentation of the selective information and the methodology used ar objective they are supported by cases.Is it possible to estimate or evaluate a come withs present and future proceeding? The answer is yes, but you exact tools and learn how to use them. Financial ratio analysis is an excellent tool for companies to evaluate their financial health in order to identify feebleness so as to institu te corrective measures. Financial ratios are first and foremost managers concern because they want to determine what divisions have performed surface. It is as wellspring stockholders concern because they want to know the value of their stock. Financial ratio is used by creditor to determine whether they will receive the m iodiney the loaned to the firm(Parrino, Kindwell, & Bates, 2011).Financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to be invested in (Financial Analysis, Investopedia). The purpose of financial statement analysis is to help users in predicting the future. In some other words, ratios are highly important profit tools that help to implement plans that improve profitability, liquidity, financial structure, reordering, leverage, and interest coverage. (Anonymous, 2000). Ratios are often able to help predict performance as well as provide indications of many potential problems. Despite the fact that financial ra tio analysis can provide imminent problems of the conjunctions performance, some important limitation should be noted when using financial ratios. In fact, most financial ratios dont tell the entire story.This paper will analyze the benefits and limitations of ratio analysis, explaining what factors impact the meaningfulness of such measures.Financial ratio analysis is a useful tool for users of financial statement. According to parino et al (2011), ratio analysis simplifies the comprehension of financial statements. They inform the financial variation of the business. Thus, one of the advantages of using this tool is to acquire information about a business. For instance, the complete debt ratio shows the use of debt in a firms capital structure. The higher the debt ratio, the more debt the follow has.Another benefit of using ratio analysis is that they facilitate comparison between different businesses, and between firms which differ in size. As an illustration, let compare the Price-Earning ratio (P/E) of two companies with different business. Recall that P/E ratio is the ratio most people are familiar with and helps one determine whether or not a stock is too high-ticket(prenominal) or a really good deal by looking at the earnings relative to stock price (Siegel, Shim, 2000).As shown above, the ratio helps to grass the trends of price-earnings of these for two different companies with different business thus, the P/E ratio may help an investor to make decision.Financial ratio can also introduce to light a companys performance, strengths and weak points. And so, the firm may looks up areas that would collect additional effort, upgrading and analysis. For instance, a high ratio inventory turnover rate ratio could mean that the company has had unexpectedly strong sales a good sign, or it could mean the firm is not managing its buying as well as it might and inventory that remains in place produces no revenue and increases the approach associated wi th maintaining those inventoriesIn addition, a ratio analysis provides an excellent and countrywide tool that helps investment decisions in the case of investors and lending decision in the case of bankers. (Parrino, Kindwell, & Bates, 2011). An example of this will be a firms need of money to finance its asset. Creditors will look at companys current ratio (current assets divide by current liabilities) to determine a companys ability to weather financial crises, at least in short term. Loans are often attached to this ratio. In the same way, investor looks at companys profitability ratios to measure how much profit a company generates when they are looking where to invest their money.As can be seen, financial ratios are remarkably helpful indicators of a firms performance, and financial situation. Although ratios analyses are useful tool, they should be used prudently.Ratios are only as good as the data upon which they are based and the information with which they are compared. (K ieso, Weygandt, Warfield, 2010)Thus, ratios analysis present some disadvantages.First, ratios are insufficient in themselves as a source of paygrade about the future (Parrino et al, 2011). They just explain interactions involving past data while users are more interested about present and upcoming information ( report for management, 2011). Basically, they give a clue or sign of the business strengths and weak points, and that in short term. Therefore, they should be used as only one of analytical tools in the management. Not to mention that ratios are ineffective when used in isolation. Most financial ratios dont tell the full story. They have to be put side by side over time for the same company or across company or with the sectors average.A single ratio actually does not make a consistent conclusion. It takes more than a ratio to be evaluated to obtain a able action, which makes ratio analyses a little bit complex. For example, the return on asset ratio (ROA), and the profit m argin ratios do not incorporate opportunity cost of risk. Similarly, the return on equity ratio (ROE) ignores cost of capital investments required to generate earnings.Another limitation is that ratio analysis depends on accounting data based on historical coast (Parino et al, 2011). According to Kiesel, the fact that ratio analysis is based on historical cost may lead to distortions in measuring performance. Given that the financial statement does not include any financial changes, a modification in price during the run period may not affect the calculated ratio. In fact, inaccurate assessments of the enterprises financial condition and performance can result from failing to incorporate honest value information ( Kieso and al, 2010)The last limitation of ratio analysis but not the least is the inflation factor. The fact that different inventory military rating (FIFO, LIFO, median(a) cost) may be in use to run a business, when prices tend to rise (inflation factor) the choice of a ccounting method is able to dramatically affect valuation ratios. To put it differently, inflation may render the comparison of financial ratios inappropriate. For instance, one business may use FIFO while another may use LIFO. If this is the case, some of the ratios, such as inventory turnover, and gross profit margin, would be disparate if pricesare rising. Another fact is that the variations of the ratios are shown to be acutely beautiful to recession (Kane, G.D, 1997). In his study, Kane, G.D affirms that value-relevance of many financial ratios are sensitive to the occurrence of recession.As has been noted, accounting policies, and inflation are some factors that have effect on the calculation of ratios.We can therefore argue that ratio analysis is practical tools for users of financial statement. Thus, it simplifies the take ining of financial report, it makes comparison between firms possible, it highlights a companys performance, and it provides an appropriate tool that he lps investor and creditors. We noted that financial ratios have some disadvantages. In fact, they are insufficient in themselves as a source of judgments they are vapid when used in isolation, and they can falsify comparisons when different accounting practices are used. All things considered, I will say that even if ratios analyses have concrete obstacles they fluent are the most useful tool in the financial world. The most important thing to keep in mind is to know how to use them, and understand their limitation.REFERENCE LISTBooks and E-BooksBooksKane, G.D (1997). The effect of recession on ratio analysis. The Mid-Atlantic Journal of Business,33 (1), 19. Retrieve from http//www.highbeam.com/doc/1G1-19568525.htmlKieso, D.,E., Weygandt, J.J., Warfield, T.D.(2010). Intermediate Accounting. New Jersey John Wiley & Sons, IncParrino, R., Kindwell, D., Bates, T. (2011). fundamental principle of corporatefinance. New Jersey John Wiley & Sons, Inc.E-BooksSiegel, J.G., Shim, J.K. ( 200 0). Dictionary of Accounting Terms, Retrieve fromhttp//web.ebscohost.com.ezproxy.umuc.edu/ehostElectronic sourcesAccounting for management, 2011. Retrieve fromhttp//accountingexplained.com/financial/ratios/advantages-limitationshttp//www.nasdaq.com/symbol/mcd/pe-ratiohttp//www.investopedia.com/terms/f/financial-analysis.aspaxzz1sqK89uaFpicpic