Using industry average ratios
Financial ratios are used to analyze a company’s strengths and weaknesses by looking at the ratio of various financial data to each other. Ratios convert financial information to a standardized format enabling them to be used to compare different companies to the industry average ratios. Company practices sometimes differ, which can produce different results so it is best to analyze a number of different ratios to get the most accurate overall comparison. Some of the ratios that can be examined and used include:
Liquidity ratios – Used to measure a company’s ability to meet short term debt obligations. It formula is current assets divided by current liabilities gives the liquidity ratio. The higher the ratio the better.
Debt ratios – Used to measure a company’s ability to pay back long-term debt. The basic debt ratio is calculated by dividing total liabilities by total assets. In this case the lower the ratio the better.
Profitability ratios – Used to measure the general financial health of a company, and are the most useful to executives for getting an overall picture of a company’s financial well being. Higher profitability ratios are desirable in a company. Two profitability ratios that can be used are: gross profit margin percentage when gross profit divided by revenue, and operating profit margin percentage – operating profit divided by revenue.
Market value ratios – Used to determine if a company is a good investment by looking at things like estimated return on investment or amount of capital invested in research. As with profitability ratios, higher market value ratios are desirable. Two ratios that provide useful information are: dividend payout ratio – dividends per share divided by net earnings per share; and dividend yield ratio – dividend per share divided by market value per share.
Comparing the ratios obtained for a company against average industry ratios gives a good idea of how well a company is doing in the field. There are many different ways of analyzing a company. If you aren’t sure how to do the analysis you need our company provides accounting assignment help.
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