What information does ratio analysis provide for meeting the requirements of the scenario?Discuss

Discussion post 1

Using Ratios To Measure A Company’s Performance
What information does ratio analysis provide for meeting the requirements of the scenario?
Potential investors want to understand how companies make decisions and how they make money. By comparing percentages from one time frame to another, the change either positively or negatively, can affect the decision to invest in a company. Ratios can show trends as well as identify areas that need attention or improvement. These comparisons can also look at a company position in a specific industry to identify leaders and overall trends for a particular market
Which ratios are the most important, and which ones are of limited value? Justify your choices for the scenario.
Capital to assets ratio are used to determine the financial health of a company. While assets include what the company owns, capital relates to the value of a company. Brand strength, number of customers, and percentage of market share all contribute to company value.
Management efficiency ratio measure changes in accounts receivables, operating expenses, inventory process, and how a company uses both long term and short term assets.
Leverage ratio analyzes how much debt a company has. Debt to equity can be significant if a company goes belly up and leaves nothing for stockholders.
Liquidity ratios are important, and significant for investment decisions. In manufacturing, there is a period of research, development and production that leads to sale of goods. A company without cash reserves, or disparities on the balance sheet to meet regular obligations can be easily identified with the calculations for current ratio (current assets/current liabilities), quick ratio (cash + accounts receivable/current liabilities) and cash ratio (cash/current liabilities).
Compnet has not paid dividends to investors and this is definitely a ratio to consider in determining the financial health and strength of a company. Ratios that would be less significant for this scenario would be price earnings and dividend payout ratios.
Why do you need to compare?
The current year ratios with the prior year ratios?
Ratios should be compared regularly, such as quarterly, annual or fiscal year end. This can identify trends, efficiencies and weakness of a company.
The ratios of competitors in the same industry or some other benchmark?
Benchmarking is an important tool for management to establish industry standards. It drives completion, innovation and development in operations, production and marketing.
Other than the computations used in ratio analysis, what else is necessary to properly analyze a company for investment?
Financial statements showing cash flow, assets, operating cost and revenues provide the information for ratio comparisons. Investors should consider a company’s rank among its industry, management and leadership, supply and demand of product or service
References
Collier, P. M. (2012). Interpreting Financial Statements. In P. M. Collier, Accounting For Managers (pp. 111-151). West Sussex: John Wiley & Sons Ltd.
Shay, R. (1995). Financial ratio analysis: Why? Savings & Community Banker, 4(1), 40. Retrieved from http://search.proquest.com/docview/195160964?accountid=34899

Discussion Post 2
M2_A2 Discussion–Using Ratios to Measure a Company’s Performance
Analyzing Compnet’s financial statements is an important step in the process when deciding whether or not investing would be a sound financial decision. The balance sheet is an useful report of balanced amounts for all the assets, liabilities and equity of Compnet from a certain date forward. The income statement reports all revenue and expenses for a specified period of time. Ratios are a comparison of two numbers with one being expressed as a percentage of the other. When researching a company for investment potential several years should be reviewed to define trend analysis of financial practices. Ratio analysis can be used to interpret performance against five criteria: 1. the rate of profitability 2. liquidity, i.e. cash flow 3. gearing, i.e. the proportion of borrowings to shareholders’ equity 4. how efficiently assets are utilized and 5. the returns to shareholders (Collier, 2012).
Several different ratios are used to evaluate profitability: return on investments (ROI), return on capital employed (ROCE), operating margin (operating profit/sales), gross margin (gross profit/sales), and sales growth. Businesses and the stock market not only like to see increasing profitability but also increasing sales, which is an important measure of the long-term sustainability of profits (Collier, 2012). Debt to equity ratio, gearing ratio, and quick ratio are the more important ratios when analyzing Compnet’s financial information. The company’s liquidity has a current ratio of 2.5 and a quick ratio of 1.99. Current and quick ratios are used in the financial world to predict an organization’s failure chances. Compnet’s current ratio is greater that 1.5 which indicates that there is enough liquidity to meet it’s short term obligations. With the current ratio equaling 2.5 this also indicates that assets are not being utilized productively which may have adverse effects on the long term prospects of the company’s future. One reason for the high current ratio could be inventory, the quick ratio doesn’t include inventory, accounting for one reason it is lower. Current and quick ratios are two parameters that identify a company’s liquidity which indicates it’s financial health. Gearing ratio is the amount of borrowings relative to shareholders equity. The higher the gearing the higher the risk of repaying debt and interest. Most businesses aim for a gearing in the range of 40.0%.
Compnet has a current asset value of $245,644.00 with liabilities equaling $98,331.00, therefore the debt ratio equals 0.58. With the debt to equity ratio equaling 1.41 there doesn’t seem to be much leverage, although the debt to equity ratio includes operational liabilities in the total. The acid test is a Better way to assess a company’s liquidity because it accounts for only the most liquid assets such as cash, short term investments and accounts receivable. the acid-test and quick ratio are used interchangeably in that current assets are divided by current liabilities. These are a variation of the current ratio. Inventory is not included due to the length of time required to reduce inventory into cash. Prepaid expenses are also excluded because thy cannot cover current liabilities. The acid-test ratio is calculated by the sum of cash, short term investments and accounts receivable divided by current liabilities. Acid-test ratio = (cash + short term investments + accounts receivable) / current liabilities.
According to Paul Colleir’s book, Accounting Practices for Managers, Ratio analysis is used to interpret trends in performance year on year; by benchmarking to industry averages or to the performance of individual competitors; or comparison against a predetermined target (2012). These trend analysis can help determine if the company’s performance is improving or needs further improvement. Through comparing current year ratios with prior year ratios and ratio’s of competitors in the same industry potential investors make judgements about the pattern or past performance, financial strength and future prospects of a company by understanding the business context and competitive conditions of the industry. When analyzing a company for potential investment opportunities, several other factors play a key role in a sound financial decision. It is important to review Compnet’s sustainability plan and statement of corporate social responsibility. Compnet’s sustainability plan should include a description and key performance indicators about the organization’s economic, environmental and social impacts.

References:
Acid test (quick) accounting ratio-calculation & example of current assets divided by current liabilities. Retrieved September 30, 2014 from http: www.accountingscholar.com/acid-test-quick-ratio.html.
Collier, Dr. Paul M. (2012). Accounting for Managers: Interpreting accounting information for decision-making (4th ed.). United Kingdom: John Wiley & Sons Ltd.