Key Outcomes and Challenges of Ratio analysis assessment in Financial Assessment
Question
Task: What are the key outcomes of ratio analysis assessment, and what challenges might one face when analyzing financial ratios analysis?
Answer
Ratio analysis assessment
Financial analysts and investors utilise ratio analysis assessment as a potent tool to evaluate a company's performance and financial health. To acquire insights into a company's profitability, liquidity, efficiency, and solvency, it entails computing various ratios based on financial documents like the balance sheet and income statement (Islami & Rio, 2019). Ratio analysis assessment has several important results, such as:
Profitability assessment
Indicators of a company's capacity to produce a profit from its activities include the gross profit margin, net profit margin, and return on investment (ROI). Better performance and financial stability are indicated by higher profitability ratios.
Liquidity evaluation
A company's capacity to satisfy its immediate financial commitments and short-term liquidity are assessed using ratios like the current ratio and quick ratio. These ratios are essential for determining the company's capacity to pay down its current liabilities.
Efficiency financial ratios analysis
The effectiveness of a company's resource and asset management is gauged by ratios like inventory turnover, receivables turnover, and asset turnover. Higher turnover rates are a sign of more effective resource use.
However, analyzing ratios also poses several challenges:
Industry and company-specific factors
To be useful, ratios must be compared to previous data and industry benchmarks. The interpretation of ratios can be considerably impacted by industry standards and business-specific factors, making it difficult to draw reliable conclusions.
Accounting practices
The computation of financial ratios analysis may be impacted by various accounting techniques and procedures. Ratio comparisons across corporations may be distorted by the adoption of various inventory valuation methodologies or depreciation strategies by various companies.
Time sensitivity
The most recent or up-to-date information may not be captured by ratio analysis assessment, which is based on historical financial records. Historical ratios are no longer as useful because of the quick changes in market circumstances and corporate dynamics.
Limited scope
Ratios give a quick glimpse of a company's financial performance, but they could miss more nuanced aspects like managerial calibre, market trends, or competitive advantages. Ratio-only analysis must take into account additional variables.
Analysts must utilise prudence, several ratios for a comprehensive picture, industry-specific benchmarks, and qualitative data and expert judgement to augment ratio analysis assessment in order to overcome these difficulties (McLaren & Struwig, 2019).
Bibliography
Islami, I. N., & Rio, W. (2019). Financial ratio analysis assessment to predict financial distress on property and real estate company listed in indonesia stock exchange. JAAF (Journal of Applied Accounting and Finance), 2(2), 125-137. https://www.enrichment.iocspublisher.org/index.php/enrichment/article/view/124. financial ratios analysis
McLaren, J. I., & Struwig, F. W. (2019). Financial ratios analysis as indicators of financial sustainability at a South African university. Journal of Contemporary Management, 16(2), 68-93. https://journals.co.za/doi/epdf/10.35683/jcm19030.0027. ratio analysis assessment
