Study of Importance of Financial Ratios

                                             Study of the Importance of Financial ratios

                                BUS 550   Financial Management

                                                 Sabin Adhikari        

                                        Presidential Business School      

                                              Westcliff University

                                     Mr. Rajan Kadel

Abstract

The paper is produced to illustrate the usefulness and importance of ratio analysis in financial planning. As well to discuss the mostly argued fundamental concept on financial performance and strategic planning derived through financial ratios. The article initially focuses on calculating the five different financial ratios with general implication of each followed by the analysis of the financial planning provides on detail the connection of each measure in business decision making process.

Ratio analysis measures the operating as well as financial performance of a company and evaluates the profitability, solvency, liquidity and efficiency during the past years and also helps managers to predict the future growth. Ratio analysis is carried out to indicate whether the organization is improving or deteriorating.

Current ratio (CR): Current assets (CA)/ Current Liabilities (CL)

Here, Current assets = Cash and marketable securities + Account receivables +Inventories +Prepaid expenses

Similarly, Current liabilities= Account/ Notes payable + Accruals

Give, CA= $376,717

        CL=$184,372

 Now, CR= CA/CL = 376,717/184,372 = 2.04 times

from the above analysis the CR is equal to industry average i.e., 2 times.

2.        Next, we know,

Give, Inventory = $212,444

Quick ratio (Acid test ratio) = Quick assets/ Current liabilities

       = (current assets- inventories)/Current liabilities

                                                   = (376,717- 212,444)/184,372

                                                   =164,273/184,372

                                                    =0.8909 times

3.        

Solution,

Given Account receivables= $141,258

Annual sales= $4,063,589

Days sales outstanding = Account receivables/ Average daily credit sales

                                      = (Account receivables/Annual sales) * 360

                                      = (141,258/4,063,589) *360

                                      = 12.51 days

Here, DSO is 12.51 days.

Next,

4.        Give, total assets = $1,177,852

Total assets turnover ratio (TATO)= Sales/Total assets

                                                =4,063,589/1,177,852

                                                =3.44 times

 Here TATO is 3.44 times.

5.        

Given, net fixed assets=711,256+89,879 =801,135

Fixed asset turnover ratio (FATR)= Sales/ Net fixed assets

                                                =4,063,589/711,256

                                                 =5.71325 times

Here the ratio is 5.71.

Strategic planning

In order to succeed in the business world, an organization should know where it is moving. In the process Strategic plans assist to elaborate and define the path. And strategic planning sets the strategic plans. Strategic planning sets the road map for any firm. While financial planning is all about the plans for finance and effective utilization of cash flows. To achieve the financial objectives, an organization carry out financial planning. However, when company sets/forecast a goal in respect to mission and vision then certain plan is carried out known as strategic planning. In simple terms strategic plan determine the set of target and financial planning ascertains that the target is reached and the measurement/examination of the financial planning is known as financial performance. In other word, financial performance evaluates the probability of achieving financial plan. And for the purpose ratio analysis is carried out (Capon, Farley & Hulbert, 1994).

Ratio analysis

Ratio analysis is the essential tool of investigating money related matters. As well as for the process of business planning, it is imperative to carryout SWOT (strength, weakness, opportunity and threat) analysis. It plays a key part in business planning process being an elementary tool of strategic analysis. According to Ansoff & McDonnell, SWOT analysis is essential part for carrying out strategic planning and SWOT analysis is incomplete without analyzing the organization’s financial position or simply ratio analysis of a company’s performance. Hence, ratio analysis is the essential part of business strategic planning.