Question

6. Assuming you are an investor, and you are given a business plan to evaluate the potential of Company XYZ. You need to perform an analysis and advise your boss on the health and performance of the business. Thus, explain the 5 (FIVE) most important ratio analysis that you will perform, and provide the interpretation of the ratios that will influence your decision. 1200 words.

Answer 1

A financial statement is the outline of all the financial activities undertaken by an organization. Companies generally have three forms of financial statements called as first The income statement second The balance Sheet and third Cash Flow Statement. All theses financial statements help to know the financial health of a firm and are useful for internal as well as external environment.

As per the question in order to ascertain the investment plan we need to analyze the five most important ratios that are directly interpreting the organization's health. They are Profitability Ratios, Liquidity Ratios, operating ratio,Activity Ratio, Performance per share ratio.

All these five ratios tells about the companies performance in various areas. Let us discuss each in brief and know their effects:

1)Profitability ratio: This ratio is being used to assess the profit earned by the company. This ratio is being used for comparative analysis of profits of different companies in the same industry. This ratio will show how much profit a firm will take for every single penny of sales. Return on the asset, Profit Margin, Return on Equity, Basic Earning Power, Gross Profit all these comes under profitability ration. Now when we will be able to ascertain this a better investment decision can be taken.

2) Liquidity Ratios: This ratio is very important as it tells the financial health of the company by ascertaining how quickly assets can be turned into cash in order to pay the company’s obligations. A high liquidity ratio means business is having a large amount of cash that can be invested in other areas or can be used for diversification. Low liquidity means a firm is struggling to pay its short term obligation. It is always advisable to invest in the business with high liquidity ration.

3)operating ratio: This ratio shows how efficient a firm is by keeping costs low while generating revenue. It shows the efficiency of a company by comparing operating expenses with sales.A decreasing operating ratio is good as it shows that operating expenses are becoming an increasingly smaller percentage of net sales..This will help in ascertaining how efficiently a firm manages its internal expenditure which is being used to increase its profit percentage.

4)Activity Ratio: This helps to measure the efficiency of an organization's in order to measure company sales per another asset account. This shows the efficiency of an organization in the utilization of its resources. The overall efficiency of the organization’s utilization can be derived with the help of an activity ratio. This helps to gauge the overall competitiveness of a firm and the overall capacity of a firm to leverage assets in the current industry.

5)Performance per share ratio: This ratio describes the value of shares to the shareholders. This ratio helps to ascertain how much money a company makes for each share of its stock and is a widely used metric for corporate profits. A higher EPS indicates investors will pay more for a company with higher profits. Performance per share includes Earnings Per Share ratio, Price to Earnings ratio, Dividend Yield ratio, Dividend Payout ratio, Market To Book ratio