FINANCIAL RATIOS.   Term Paper ID:29676 Click to get this paper

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Paper Abstract: Application of financial ratio analysis. Using it to assess the financial strengths and weaknesses of companies. Appropriate uses including calculation and comparison of ratios from company's financial statements. Absolute values and historical trends of the ratios within a company. Leverage, liquidity, operational, profitability and solvency ratios. Five Tables. Paper Introduction: USING FINANCIAL RATIOS TO ASSESS THE FINANCIAL STRENGTHS AND WEAKNESSES OF COMPANIES 1. Introduction The purpose of this research is to review the application of financial ratio analysis to assess the financial strengths and weaknesses of companies. The presentation of the findings of the review begins with a consideration of the appropriate uses of financial ratios. This presentation is followed by illustrations of the application of financial ratio analysis to assess the strengths and weaknesses of companies. 2. Financial Ratios and Their Appropriate Applications Financial ratio analysis involves the calculation and comparison of ratios derived from the information in a company’s financial statements. Analysts typically depend upon the au Text of the Paper: The entire text of the paper is shown below. However, the text is somewhat scrambled. We want to give you as much information as we possibly can about our papers and essays, but we cannot give them away for free. In the text below you will find that while disordered, many of the phrases are essentially intact. From this text you will be able to get a solid sense of the writing style, the concepts addressed, and the sources used in the research paper. Journal of Small business Management, 39(2), 152-164.Pottier, S. Theillustrate the application of this approach, an Altman Z-Score wasdeveloped for The Boeing Company based on financial data for the company's1999 fiscal year. 1:1 |3.2 Applying Financial Ratio Analysis to Assess a Company's Risk of Bankruptcy There are more than two-dozen financial ratios, each of which providesanalysts with some information with which to assess the probability ofbankruptcy for a company, and none of which, alone, provides a consistentindicator of the probability of bankruptcy. The CPA Journal, 65(2), 52-53.McMahon, R. The mostproved of these algorithms is the Altman Z-Score (Eidleman, 1995). The individual financial ratios included in the Altman Z-Score determination are presented in Table 3.2.1. As indicatedearlier in this discussion, consideration of the value of a ratio inrelation to the historical trend in the company provides one contextualrelationship. Analyzing financial ratios. Financial ratios are calculated from one or more pieces of informationfrom a company's set of financial statements. Both the absolute values of the ratio and the historical trends of theratios within the company enable analysts to make inferences about acompany's financial performance, financial position, and the company'sattractiveness as an investment vehicle (McMahon, 2 1). When an Altman Z-Score is higher than 3. As noted at the beginning of this discussion, financial ratios otherthan those included in the Altman Z-Score determination also provideinformation relative to the probability of bankruptcy. Taken together, all of the rations present acomprehensive assessment of a company's financial performance and financialposition. Context provides meaning to financial ratios. There is alwaysthe danger when applying financial ratio analysis that the analyst or themanager will be preparing to fight the last war rather than the next war(Davis & Largay, 1999). Cash flowstatements also provide information required for the calculation of someratios (McMahon, 2 1). Seattle, Washington: Boeing Company.Davis, M. The more commonly appliedfinancial ratios are grouped into classes that focus on specific aspects offinancial performance or financial position. Financial ratios have meaning only when they areapplied to appropriate financial analysis objectives (Davis & Largay,1999). 57 |1.2 |. P. Financial reporting of "significant-influence" equity investments: Analysis and managerial issues. 2. Illustrations of the Application of Financial Ratio Analysis3.1 Applying Financial Ratio Analysis to Assess A Company's Financial Performance The company i2 Technologies is used as an example for the applicationof financial ratio analysis to assess a company's performance. A. The most importantof these other ratios are those related to liquidity, profitability, andfinancial leverage (Pottier, 1998). using financial ratios to assess the financial strengths and weaknesses of companies 1. Introduction The purpose of this research is to review the application of financialratio analysis to assess the financial strengths and weaknesses ofcompanies. G. Annual report 1999. (2 ). (2 1, April). , company's generally areconsidered to be safe from bankruptcy. Scores from 2.7 to 3. Each of the groups offinancial ratios can provide a detailed look at a specific area offinancial performance in a company or a specific aspect of a company'sfinancial position. Typically, the balance sheetand the revenue statement provide most of the required data. These ratios for The Boeing Companybased on fiscal 1999 data are presented in Table 3.2.2. One of the problems with financial ratio analysis is its heavydependency on historical data and historical trends. Comparing the value of a company's ratio with the ratios ofother companies in the same industry or with an industry norm reflectingperformance over a period of year (five years is a typical example)provides another contextual relationship (McMahon, 2 1). Z scores - a guide to failure prediction. Scores from 1.8 to 2.69 indicate thatbankruptcy is likely within two years, and scores below 1.8 indicate that afirm is headed for bankruptcy from which it likely will not recover(Eidleman, 1995). The financial ratio data presented in Table 3.2.2 do not change theassessment of the bankruptcy probability for The Boeing Company based onthe Altman Z-Score determination. Based on the Altman Z-Score, The Boeing Company appearsto be safe from bankruptcy. It is true thattechniques exist for the projection of some financial ratios for futureperiods; however, such projections hold their own risks. Unfortunately, universal agreement of which ratios are mostimportant does not exist (Pottier, 1998). 19 ||Equity / Total | | | ||Liabilities | | | ||Sales / Total |1.6 4 |1. (1994). 68 ||Current | | | ||Liabilities] / | | | ||Total Assets | | | ||Retained Earnings|.29 |1.4 |.4 6 ||/ Total Assets | | | ||Market Value of |1.699 |.6 |1. Thispresentation is followed by illustrations of the application of financialratio analysis to assess the strengths and weaknesses of companies. The Altman Z-Score for the Boeing Company at the end of 1999 was 3.44. (1998, June). Considered in isolation, a financial ratio is not especiallymeaningful. (1999, Fall). Some ratios, however, areviewed by analysts as being more important than others for the predictionof bankruptcy. % |Source (raw data): Boeing Company 2 ReferencesAmerican Institute of Certified Public Accountants. Several algorithms incorporating different ratios have been developedto improve the prediction of the probability of bankruptcy. Business growth and performance and the financial reporting practices of Australian manufacturing SMEs. 1 times total long-term capital]Table 3.1.2Financial Leverage Ratios|Entity |1997 |1996 |1995 |1994 |1993 ||i2 Technologies |1. 8X |1.45X |2.62X |2.32X |1.21X ||Industry | .74X | .8 X | .82X | .86X | .91X | X = times [i.e., total assets in 1993 were 1.11 times total equity]Table 3.1.3Current Ratios|Entity |1997 |1996 |1995 |1994 |1993 ||i2 Technologies |1.99:1 |2.96:1 |1.54:1 |2.33:1 |1.83:1 ||Industry |1.38:1 |1.56:1 |1.73:1 |1.99:1 |2. |1.6 4 ||Assets | | | ||[EBIT + Interest |.1 4 |3.3 |.343 ||Expense] / Total | | | ||Assets | | | ||The Boeing Company Z-Score |3.44 |Source (raw data): Boeing Company 2 |table 3.2.2 - Other financial ratios relative to bankruptcy: the ||boeing company 1999 ||Ratio |Boeing Measure ||Current |1.15X ||Quick |.67X ||Long-Term Debt/Equity |.522X ||Total Liabilities/Equity |2.154X ||Average Collection Period |21.72 days ||Return on Equity |2 .1% ||Return on Total Capital [Equity + |13.2% ||Long-Term Debt] | ||Return on Total Assets |6.4% ||Return on Sales |4. W. 1X ||Industry | .74X | .8 X | .82X | .86X | .91X | X = times [i.e., long-term debt in 1993 was 1. indicatethat a company likely is safe, although this score range is a gray areawhere caution is indicated. 1:1 |Table 3.1.4Quick Ratios|Entity |1997 |1996 |1995 |1994 |1993 ||i2 Technologies |1.99:1 |2.96:1 |1.54:1 |2.33:1 |1.83:1 ||Industry |1.38:1 |1.56:1 |1.73:1 |1.99:1 |2. In theseexamples, selected ratios are calculated and compared over a five-yearperiod.Table 3.1.1Debt Ratios|Entity |1997 |1996 |1995 |1994 |1993 ||i2 Technologies | .29X | .18X | .56X | .77X |1. L., & Largay, III, J. New York: American Institute of Certified Public Accountants.Boeing Company. There are many different financial ratios. Journal of Risk and Insurance, 65(2), 275-287. Life insurer financial distress, Best's ratings and financial ratios. Bankruptcy for The Boeing Company in thenear future remains unlikely. The presentation of the findings of the review begins with aconsideration of the appropriate uses of financial ratios. 3. Financial Ratios and Their Appropriate Applications Financial ratio analysis involves the calculation and comparison ofratios derived from the information in a company's financial statements.Analysts typically depend upon the audited statements of a company(McMahon, 2 1). Journal of managerial Issues, 11(3), 28 -288.Eidleman, G. In context, a financial ratio can provide indications of performancetrends in a company, as well as highlighting variations between a company'sperformance and the performance of the industry of which it is a part.Such performance indicators provide information that management can use toimprove the performance of a company or to reverse risky trends inperformance (Davis & Largay, 1999). |table 3.2.1 - altman z-score determination: the boeing company 1999 ||Ratio |Boeing Measure |Z-Score Weight |Z-Score Value ||[Current Assets -|. J. The most frequently encountered groups of financial ratios,together with their focus areas, are as follows (American Institute ofCertified Public Accountants, 1994): > Leverage Ratios indicate the extent that debt is used in a company's capital structure; these ratios indicate the extent to which a company is operating on someone's money other than its own; to a point, a company benefits from operating on borrowed money; after that point is reached, however, a company's risk of insolvency may increase > Liquidity Ratios reflect a company's short term financial situation or solvency; these ratios focus on current assets and liabilities - what the company owes within 12 months and the assets it can rely on to pay those debts within 12 months > Operational Ratios measure asset turnover to assess the efficiency of a company's operations; sales and a multiple of assets is one example; cost of sales as a multiple of inventory is another example > Profitability Ratios measure the return on some aspect of the company's operations; return on equity is one example; net profit on sales measure profitability from a different perspective > Solvency Ratios measure the performance of a company in relation to its capacity to generate the cash flow required to assure that it will be able to meet all of its financial obligations over the long term The major justification for classifying financial ratios in relationto specific areas of analytical interest is to assure that the mostappropriate financial ratio is used to assess a specific area of acompany's performance. 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