FREE online courses on Financial Ratio Analysis - Comparing Financial Statements - Summary

 

We started our look at ratio analysis with Return on Equity since this one ratio is at the heart of financial management; namely we want to maximize returns for the shareholders of the company. Secondly, we have three ways of influencing Return on Equity. We can change our profit margins, we can change our turnover of assets, or we can change our use of financial leverage. Next, we looked at how we can influence the three components of Return on Equity.

There are several detail ratios that we can monitor, such as acid test, inventory turnover, and debt to equity. Detail ratios help us monitor specific financial conditions, such as liquidity or profitability.

 

Ratios are best used when compared or benchmarked against another reference, such as an industry standard or "best in class" within our industry. This type of comparison helps us establish financial goals and identify problem areas.

 

We also can use vertical and horizontal analysis for easy identification of changes within financial balances.

 

It should be noted that ratios do have limitations. After all, ratios are usually derived from financial statements and financial statements have serious limitations. Additionally, comparisons are usually difficult because of operating and financial differences between companies. None-the-less, if you want to analyze a set of financial statements, ratio analysis is probably one of the most popular approaches to understanding financial performance.