D076 - Finance Skills for Managers Unit 4

4 Reasons Ratios are Useful - 1 - Standardization 2 - Flexibility 3 - Focus 4 - Evaluation Benchmarking - The process of completing a financial analysis and comparing a firm's performance to that of other similar firms. Trend Analysis - Comparing a firm's ratios across time Cross-Sectional Analysis - Compares a firm's financial ratios to other firms' ratios or industry averages Seasonal Firms - Firms whose performance varies according to the season. Which statement below is an example of how ratios are used in the field of finance? - A firm's ratios are compared with those of a benchmark peer group to determine the firm's relative strength and performance. - Ratio analysis is performed based on a strict set of rules governed by generally accepted accounting principles. - A firm's ratios may vary year over year, so they are not helpful for evaluating whether firm goals are met. - Ratios are helpful only when comparing companies that are the same size and that use the same operational style. - A firm's ratios are compared with those of a benchmark peer group to determine the firm's relative strength and performance. Why are ratios considered flexible? - Because they are not regulated and can be changed or invented according to a firm's needs How might calculating financial ratios help shareholders? - Ratios can be used to determine whether a firm is maximizing shareholder wealth. The firm Betsy's Books conducts a financial analysis using ratios to know how it is performing in comparison to other similar firms. What is this process called? - Benchmarking 5 Major Categories of Ratios - 1 - Liquidity 2- Activity 3 - Leverage 4 - Profitability 5 - Market Liquidity Ratios - measure a firm's ability to meet short-term obligations and include the current ratio and quick ratio. Activity Ratios - AKA Efficiency ratios; measure how well the company uses its assets to generate sales or cash -- the firm's operational efficiency and profitablilty. Leverage Ratios - A category of ratios that consider how a firm is financed, aka financing ratios or solvency ratios. Profitability Ratios - A category of ratios that are commonly used to directly judge how well management is doing as they strive to maximize owner wealth.