Department of Financial Management
Basic Business Finance 1
Financial Ratio Analysis – Part 1
1. Ratio Comparisons
Robert Arias recently inherited a stock portfolio from his uncle. Wishing to learn more about the companies that he is now invested in, Robert performs a ratio analysis on each one and decides to compare them to each other. Some of his ratios are listed below. (Gitman – Principles of Managerial Finance – 10th Ed.)
| |Island Electric | | | |
| |Utility |Burger Heaven |Fink Software |Roland Motors |
|Ratio | | | | |
|Current ratio |1.10 |1.30 |6.80 |4.50 |
|Quick ratio |0.90 |0.82 |5.20 |3.70 |
|Debt ratio |0.68 |0.46 |0 |0.35 |
|Net profit margin |6.2% |14.3% |28.5% |8.4% |
Assuming that his uncle was a wise investor who assembled the portfolio with care, Robert finds the wide differences in these ratios confusing. Help him out.
Answer the following questions:
a. What problems might Robert encounter in comparing these companies to one another on the basis of their ratios?
The main problem in this case is that the companies being compared to one another belong to different industries. We know that each industry has unique characteristics, particularly in the range of acceptable financial ratios.
b. Why might the current and quick ratios for the electric utility...