Running head: FINANCIAL RATIOS 1
FINANCIAL RATIOS: THE GOOD AND THE BAD
Juan C. Martinez
Juan C. Martinez, EBM625 Advanced Financial Management, Stratford University.
Correspondence concerning this article should be addressed to Juan C. Martinez, EMB625 Advanced Financial Management, Stratford University, 7777 Leesburg Pike, Falls Church, VA 22043. E-mail: [email protected]
FINANCIAL RATIOS 2
This paper will discuss financial ratio analysis reasoning types and limitations. Financial ratio analysis is the calculation and comparison of ratios which are derived from the information in a company’s financial statements. The information and historical trends of these ratios can be used to make presumptions about an organization’s current and future financial condition, daily operation effectiveness, and attractiveness as an investment to investors (Corrado, Jordan, 2000). Financial ratios help us identify some of the financial strengths and weaknesses of a company. These ratios give the user two ways of making meaningful comparisons of a company’s financial data: 1) we can examine the ratios across time, one to five years usually, to identify any trends; and 2) we can compare the firm’s ratios with those of other firms within the same industry and relative capitalization. A major objective in using a ratio when analyzing financial information is simply to standardize the information being analyzed so that comparisons can be made between ratios of different firms or possibly the same firm at different points in time (Keown, etal, 2001). Yet financial ratio analysis has its limitations. Concern must be emphasized in regards to ratio analysis because limitations may be encountered in computing and interpreting financial ratios like: difficulty in identifying an appropriate industry category to compare against, accounting...