Question

Select seven ratios to use at year-end and describe what each ratio is used for.

Answer 1

Financila ratios are used to evaluate the performance of a company at year end.

Seven ratios are as follows:

1. Current ratio - This is a ratio of current assets to current liabilities. This is used to evaluate the ability of a company to meet its current liabilities using current assets. Ideally current ratio should always be more than 1.

2. Net profit margin - This can be calculated as Net Income / Net Sales * 100

This ratio can be used to evaluate the profit margin or the incoem that teh company has been able to generate in comparison to its sales.It measures the overall profitability of the company. Higher this ratio, the better it is.

3. Return on assets - This ratio is used to evaluate the income generating capabilities of the assets. It is calculated by dividing net income by the average assets. Higher the return the better it is.

4. Debt to Equity ratio - It is a ratio of Debt and Equity of a company. This ratio compares whether the fiem uses more of equity or is dependent on debt. Debt increases interest cost but provides leverage benefits. A company should use a balance of debt and equity and should not depend too much on any one.

5. Interest Coverage ratio - This is the ratio of earnings before interest and tax dividend by the interest expense. It is used to evaluate whether the company has enough profits to pay its interest obligations. The higher this ratio, the better it is.

6. Accounts receivable turnover ratio - This is the ratio of net sales to average accounts receivables. It is used to evalaute the operating efficiency of the firm. It shows haw fast a business is able to convert sales into cash.

7. Earnings per share - This is a ratio very useful for investors. This ratio indicates the net income per common share of the company. Higher this ratio the better it is.