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Ratios/Profit Margin - Assignment Example


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Ratios/Profit Margin

In special cases, ratio analysis is done to help in predicting possible future bankruptcy of the company. The main financial ratios used in most cases include: Liquidity ratio, financial leverage ratio, asset turnover rations, dividend policy ratios and profitability rations. Generally, these ratios are useful indicators of a firm's performance and the prevailing financial situation. Do ratio tells the whole story? To some extents, financial ratios play an important role by providing an overview of accounting and financial position of the company. However, ratios do not give the overall picture of the organization. This is because it depends on historical figures which are bound to change due to certain seasonal factors. In the same note, ratios are highly subjected to manipulation and this affects credibility of the outcome. This implies that adjustments can be made on earnings to predict higher returns to the company. Based on this view, it means that ratios may mislead and should be treated with a lot of caution when interpreting financial position of the company. Liquidity Ratios Liquidity ratios are used to determine the ability of the firm to accomplish short term financial needs. It mainly applies to parties who extend short term credit facilities to the company. Two main liquidity ratios include: Current Ratio and Quick ratios. Current Ratio: This is calculated by dividing current asset by current liabilities. The formula for current ratio is as follows: Current Ratio (C.R.) = Current

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Asset (C.A.)/ Current Liabilities (C.L.) Quick Ratio: This is calculated by dividing the value of Current Asset (CA) less Inventory by Current Liabilities. The formula for quick ratio is as follows: Quick Ratio (QR): (Current Asset (CA) - Inventory)/ Current Liabilities (CL) How investors can use Liquidity Ratios for investment decisions Liquidity ratio is an important tool for investment decisions. It measures the speed at which the company’s assets can be converted into cash to support short term financial needs. As such, the ratio provides investors with an idea on the capability of the company to raise cash quickly to repay creditors or purchase more assets during normal business operations, as well as, in emergency situations. Having such an idea helps investors in deciding whether the company is in good financial health and should put more investments into the business. How debt service ratios can be used by a lender in determining whether or not to lend money to a company. Response 1 (Jamie Moore) Debt service ratio is used by financial lenders as a preliminary assessment method to know whether an individual (borrower) is already suffering from too much debt from the previous borrowings. It specifically gives the proportion of an individual’s gross incomes that is committed in the repayments of other loans. In case the established ration is 40 percent or less, then it implies that the borrower has a relatively acceptable debt levels. Any value above this percentage is a sign of unhealthy financial performance. Response 2 (Venessa Thompson) Financial stability requires that a person or company should have income adequate to pay off debts. Debt service ratio is a model used in evaluating the relationship between disposable income and debt payments. Examples of such debts include mortgages loans, car loans and students’ loans. Therefore, debt service ratio is a tool used by banks to examine the likelihood of a borrower to default during loan


Ratios and Profit Margin Insert name Name of the university DISCUSSION 1: RATIOS Firm’s performance can be predicted by use of financial ratios. When calculating financial ratios, information is generated from company’s financial statements…
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Ratios/Profit Margin essay example
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