Ratio Analysis

Companies strive from day to day to make their business publicly strong, financially strong, and appeasing and profitable for its shareholders. Shareholders as well as the company's management use several tools to determine a company's health and direction. These tools are better known as ratio analysis. Ratios are among the more widely used tools of financial analysis because they provide clues to and symptoms of underlying conditions.2 Ratios help measure a company's liquidity, activity, profitability, leverage and coverage.1 These five measured sections show how ratio analysis is used in decision-making, how a firm can measure its financial situation and financial performance, and the strengths and weaknesses of the company.

The term ratio analysis can be broken down into smaller sections. The first is a current ratio which is the ratio of current assets to current liabilities. This ratio shows how well a company's current liabilities are covered.1 Even though this ratio is used often, it does have its limitations. Since it shows all current assets it does not differentiate among the assets with regard to their degrees of liquidity, show it can show skued results .Another commonly used ratio is the acid-test ratio, also known as the quick ratio. This ratio shows an investor how the short-term liquidity, or how quickly the company's assets can be turned into cash.2 Inventory turnover is an important and often overlooked ratio that indicates inventory levels. A low turnover is usually a bad sign because products tend to deteriorate as they sit in a warehouse. There is also weaknesses associated with inventory turnover such as, companies selling perishable items have very high turnover.3 Another ratio is the receivables turnover which shows how frequently a company converts receivables into cash. An investor typically is in favor of a high receivable turnover because it means that the company doesn't need to commit large amounts of funds to account receivables. However, an accounts receivable can be too high which can occur when credit terms are so restrictive that they negatively affect sales volume. 2 A final activity ratio to use is the fixed asset turnover ratio which is useful to determine the amount of sales that are generated from each dollar of assets. Companies with low profit margins tend to have high asset turnover, those with high profit margins have low asset turnover.3 Some of the most used and examined ratios are the profitability ratios which measures performance