Ratio Analysis

From WikiEducator
Jump to: navigation, search

Ratio Analysis Ratio Analysis can be defined as the study and interpretation of relationships between various financial variables, by investors or lenders. It is a quantitative investment technique used for comparing a company's financial performance to the market in general. A change in these ratios helps to bring about a change in the way a company works. It helps to identify areas where the management needs to change.

Types of Ratios Calculated A number of ratios are calculated by companies for evaluating their short and long term performance and also to know liquidity and profitability. Some of the most commonly used ratios are:

Liquidity ratios: Can be defined as a ratio that indicates what proportion of a company's assets can be readily converted into cash in the short term. Some of the liquidity ratios are: • Current ratio • Quick ratio • Defensive interval ratio • Activity ratio • Acid turnover • Receivable turnover • Inventory turnover Profitability ratio: Can be defined as a ratio that explains the profitability of a company during a specific period of time. It explains how profitable a company is. These ratios can be compared during different financial years to see the overall performance of a company. Some of the profitability ratios calculated are: • Return on assets • Return on common stock equity • Profit margin • Leverage ratio • Debt ratio • Equity ratio • Debt to equity ratio • Times interest earned • Degree of financial leverage • Per share ratios • Earnings per share • Price earnings ratio • Book value per share • Yield on common stock • Dividend payout ratio

Accounts payable is the amount of money that a company owes to its vendors for goods and services purchased on credit. It is a current liability of a company and has to be fulfilled within a year.

Accounts payable result in negative cash flow of a company at the time they are paid off. Every company keeps a track of its accounts payable and also the time period when it is to be paid.

Accounts payable reconciliation & management can be a time consuming process and can take a long time to resolve discrepancies. Large organizations therefore use accounting softwares or take the help of professional accounting firms for managing its accounts payable. A close check should also be made on fraudulent invoices, to prevent embezzlement.

Accounts Payable Auditing Professional auditors insist their clients to provide approved invoices, supporting documents and expense reports at the time of making payments through checks and other methods. This helps to keep a track of all the documentation related to purchase and also keep a check on the genuineness of invoice. Inflated or duplicate invoices get eliminated at this stage.

Advantages of Accounts Payable Outsourcing Outsourcing the accounts payable process can help the organization by: Providing a method of internal control Providing expense administration Providing monthly reconciliation of accounts payable Saving time and man hours Preventing fraudulent invoices Preventing overpayment and duplicate invoices

Accounts receivable is the amount of money owed to an individual, company, organization for the goods / services provided to them. It is a current asset of a company and represents the amount that customers owe to a business. Accounts receivable are payable by the customers within a year from the date of sale of goods / services.

Accounts receivable service is a vast area and includes : 

Accounts receivable recognition Accounts receivable valuation Accounts receivable disposal These processes can be cumbersome and time consuming therefore, large organizations either use accounting softwares or outsource the process to professional accounting firms. This helps to manage it in a better way.

Organizations realize that not all debts will be collected and recovered, so they make an allowance for bad debts, that are in turn subtracted from the total accounts receivable. Accounting firms collect debts on behalf of their clients through settlement offers, payment plan negotiation and sometimes legal action.

Advantages Accounts Receivable Outsourcing Outsourcing the accounts receivable provides the following advantages: Ensuring internal control Effective expense administration Timely reconciliation of accounts receivable Saving time and man hours Preventing fraudulent invoices