Ratio Analysis Paper

1236 words - 5 pages

IntroductionIn this paper, I will discuss the profitability, liquidity, and solvency ratios that affects acompany. The limitations of ratios and bench marking capabilities. Along with three questionsthat would provide good information about what ratios are important, which ones are importantto internal management and which ones are important to the creditors. The reader would have abetter understanding of each of the items that will be discuss in this paper.Probability RatioThe probability of an outcome for a particular event is a number telling us how likely aparticular outcome is to occur. This number is the ratio of the number of ways the outcome mayoccur to the number of total possible outcomes for the event. Probability is usually expressed asa fraction or decimal. Since the number of ways a certain outcome may occur is always smalleror equal to the total of outcomes, the probability of an event is some number from 0through 1.An example of a probability ratio would be as follows: Suppose a regular dice isrolled. What is the probability of getting a 3 or a 6? "There are" a total of 6 possible outcomes.Rolling a 3 or a 6 are two of them, so the probability is the ratio of 2/6 = 1/3. Website:http://www.mathleague.com/help/percent/percent.htm Retrieved on February10, 2009.Liquidity RatiosCommon liquidity ratios include the current ratio, the quick ratio and the operating cashflow ratio. Different analysts consider different assets to be relevant in calculating liquidity.Some analysts will calculate only the sum of cash and equivalents divided by current liabilitiesbecause they believe that they are the most liquid assets, and would be the most likely to be usedto cover short-term debts in an emergency. A company's ability to turn short-term assets intocash to cover debts is of the utmost importance when creditors are seeking payment. Bankruptcyanalysts and mortgage originators frequently use the liquidity ratios to determine "whether" acompany will be able to continue as a going concern. This website was retrieved on February 10,2009: http://www.investopedia.com/terms/l/liquidityratios.asp .Solvency RatioOne of many ratios used to measure a company's ability to meet long-term obligations.The solvency ratio measures the size of a company's after-tax income, excluding non-cashdepreciation expenses, as compared to the firm's total debt obligations. It provides ameasurement of how likely a company will be to continue meeting its debt obligations. Themeasure is usually calculated as follows:Acceptable solvency ratios will vary from industry to industry, but as a general rule ofthumb, a solvency ratio of greater than 20% is considered financially healthy. Generallyspeaking, the lower a company's solvency ratio, the greater the probability that the company willdefault on its debt obligations.Limitations of Ratios AnalysisAccounting Information has different policies that has choices that may changecompany comparisons. Like for instance, the business...

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