Ratio Analysis Essay

698 Words Apr 15th, 2005 3 Pages
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.
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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 to indicate what a company is earning on its sales, assets, or equity.1 These ratios include the operating profit margin, net profit margin, return on equity and the earnings per share ratio. The operating profit margin and the net profit margin work hand in hand. They show how much a company earns before interest and taxes for every dollar of sales and the amount after interest and taxes for every dollar of sales, respectively.1 One of the most looked at ratios is the return on equity. Return on equity tells the rate that shareholders are earning on their shares. Companies that generate high returns relative to their shareholder's equity are companies that pay their shareholders off handsomely, creating substantial assets for each dollar invested.3 The last two ratios looked at are the debt to net worth ratio and the time interest earned. The times interest earned reflects the creditors' risk of loan repayments with interest. The larger this ratio, the less risky is the company for creditors. One guideline says that

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