Improving Financial Ratios - Essay Example

It is critical to note that financial ratios can also be improved with the help of creative accounting techniques such as the use of different depreciation methods, inventory value methods, etc.

Financial ratios are typically characterized into five groups and each group consists of different ratios that outline the performance of the firm in that category. For example, liquidity ratios comprise the current ratio as well as the acid test ratio. To improve upon the liquidity ratios of a firm, a firm can discipline its use of working capital. Since liquidity ratios mostly indicate the firm’s ability to pay off its short-term liabilities with its short-term assets therefore both the current assets as well as current liabilities must be managed in an optimum manner. To improve this ratio, a firm can decrease its reliance on short-term finance and shall encourage the use of internally generated funds to finance its short-term working capital requirement. Since current assets are considered non-productive assets it is therefore important that a balance must be achieved between the current assets and current liabilities to bring the ratios to the most favorable condition.

Similarly, efficiency ratios indicate the efficiency with which the assets of the firm are managed by the managers. To improve the efficiency ratios, a firm can further tighten its credit extension policy to improve its receivable turnover. This can also be achieved by making the sales activity more robust so that inventories are rotated more frequently rather than piling up after their production. A higher inventory turnover, therefore, indicates the ability of the firm to convert its inventories into cash or receivables through sales generation.

Profitability ratios can be improved by either reducing the cost or improving the profitability of the firm. Cost rationalization can be achieved by focusing on the core activities of the firm and further disciplining them to achieve the maximum input/output ratio. Profitability ratios can also be improved by adapting different accounting techniques such as recording depreciation. Adapting different methods of depreciation will provide different estimates and hence they will impact the profitability accordingly. (Brigham & Ehrhardt, 2008)

Lastly, to improve the leverage ratios, the firm must be able to either rationalize its debt management or inject more equity into the firm. To bring back the capital structure to its most optimum level, the firm must achieve a balance between its ratio of debt and equity.