ratio analysis Essay

Price earnings ratio is a valuation ratio of a company's current share price compared to its per-share earnings. Coca-Cola has a lower P/E ratio than Pepsi Co. The industry average for P/E ratio is 21.1. This means neither of the companies beat the industry average ratio. Between the

There are quite a few reasons for choosing the three ratios mentioned above. One big reason for our selection is due to the popularity of these ratios. By having a lot of popularity, we can be sure that our audience will be familiar with what we are talking about, without having to waste too much time explaining. Another reason for choosing these three ratios is that they are relatively easy to calculate. A final reason for picking our three ratios is because they allow us to understand why a company may be outperforming or underperforming in term of profitability, without having to be a professional.

Ratios are highly important profit tools in financial analysis that help financial analysts implement plans that improve profitability, liquidity, financial structure, reordering, leverage, and interest coverage. Although ratios report mostly on past performances, they can be predictive too, and provide lead indications of potential problem areas. Financial ratios are important because they help investors make decisions to buy hold or sell securities.

Price-earnings Ratio: measures market value relative to earning by dividing market price per common share by earnings per share.

Price to earnings ration. This ratio is used in conjunction with other metrics to give analyst and investors are quick initial impression of whether a company would make a good investment. (investopedia, 2014)

There is a essential use and limitations of financial ratio analysis, One must keep in mind the following issues when using financial ratios: One of the most important reasons for using financial ratio analysis is comparability and for this, a reference point is required. Usually, financial ratios are compared to historical ratios of the business itself, competitor’s financial ratios or the overall ratios of the industry in question. Performance may be adjudged as against organizational goals or forecasts. A number of ratios must be analyzed together to get a true and reliable picture of the financial performance of the business. Relying on each ratio

Ratio analysis shows the correlation within certain figures of financial statements, like current assets and current liability, and is used for three types of company needs- within, intra- and inter-company. Association can be shown in proportion, rate, or percentage and can evaluate company’s liquidity, profitability, and solvency. Liquidity ratios show company’s ability to pay obligations and fulfill needs for cash; profitability ratios show wellbeing and success for the certain time period; and solvency ratios show company’s endurance over the years.

The ratio measures the company’s ability to meet its debt obligations. It allows investors to see to what extent company’s earning can decline without the firm being unable to pay its annual interest costs. Nevertheless, a high ratio can indicate that a company has an undesirable lack of debt or it is paying too much debt with earning that could be invested in other projects.

Financial ratios are great indicators to find a firm’s performance and financial situation. Most of the ratios are able to be calculated through the use of financial statements provided by the firm itself. They show the relationship between two or more financial variables that can be used to analyze trends and to compare the firm’s financials with other companies to further come up with market values or discount rates, etc.

9. Debt service coverage = (Net Income + Interest + Depreciation) in Statement of Operations/ Interest + Principal Payments ($10 million assumed for this assignment)

Financial ratios can be used for a quick comparison to other companies in the industry and to the same company over time. They allow you to ignore the numbers and focus on their relationships.

Market value ratios are probably the most important ratios for any publicly traded company; it’s an indicator of how well the company is perceived as a whole. It reflexes how investors view the future performance and risks of the company. One such market value ratio that is used commonly is the cash flow per share ratio. This ratio is measured by taking the operating cash flow – preferred dividends divided by the common shares outstanding. This ratio is more reliable than the EPS or earnings per share ratio because it is less likely to be manipulated. Because of this the cash flow per share ratio is judged to be a better indicator of a company’s strength and position within the market. For 2013 Disney had the highest cash flow per share ratio amongst its competitors which was valued at 5.29. This was slightly better than Time Warner’s which was 4.04 and was significantly better than Fox’s 1.28.

The calculation of ratios is the calculation technique for analyzing a company’s financial performance that divides or standardize one accounting measure by another economically relevant measure. Financial ratios can be used as a tool to demonstrate financial statement users for making valid comparisons of firm operating performance, over time for the same firm and between comparable companies. External investors are mostly interested in gaining insights about a firm’s profitability, asset management, liquidity, and solvency.

Firms and Companies include ‘Ratios’ in their external report to which it can be referred as ‘highlights’. Only with the help of ratios the financial statements are meaningful. It is therefore, not surprising that ratio analysis feature are prominently in the literature on financial management. According to Mcleary (1992) ratio means “an expression of a relationship between any two figures or groups of figures in the financial statements of an undertaking”.

Ratio analysis is generally used by the company to provide some information on how the company has performed during that year, so that the parties involved including shareholders, lenders, investors, government and other users could make some analysis before making any further decision towards that particular company. As mentioned by Gibson (1982a cited in British Accounting Review, 2002 pg. 290) where he believes that the use of ratio analysis is such an effective tool to evaluate the company’s finance, and to predict its future financial state. Ratios are simply divided in several categories; these are the profitability, liquidity, efficiency and gearing.