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Financial Analysis RatiosEssay

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Ratio and Financial Statement Analysis

The topic for this essay is ratio and financial statement analysis. It is meant to show and analytically examine the benefits and confines of ratio analysis by elucidating what factors impact the significance of such methods and what new theories or practices may be developing regarding the presentation and application of ratio and financial statement analysis. Emphasis on practical applications will come from peer-reviewed articles.

The articles are within the last five years as well as use real-world ratios synthesizing. They are a mixture of researched material and studies. From the start of January 1, 2011, the majority of the world fiscal market economies utilize International Reporting

Standards or IFRS as the obligatory outline for financial statements. This has a large part to play in the significance of ration and financial statement analysis.

Studies like one done in Romania through use of logistic regression attempts to see if this methodology can be employed as a model to precisely forecast the business bankruptcy likelihood over the fiscal crisis period. Through financial statement analysis, by utilizing synthetic financial statements, they constructed twelve ratios and from these twelve, five proved major within forecast of corporate bankruptcy in a logistic model. This is an example of real world application of ratios to solve real world problems.

Another real world application of ratios and financial statement analysis examines how a retailer's accounts receivable quantities and the business' days' transactions in accounts receivable are influenced by the company's selection of whether to preserve the management of its credit-card process in-house or subcontract it to an economic institution. It highlights the rising trend toward subcontracting of credit-card processes. It also shows how it generates major difficulties for analysts as they try to make intra- and inter-firm assessments of retailers' using the DSAR metric. Here is an excellent example of the growing obstacles put in front of those utilizing ratios and financial statement analysis.


Computation or analysis of financial ratios as well as when performing other financial statement analysis is a complex and ongoing process. Those that practice such methods must always keep in mind that accounting principles are reflected in the financial statements. This signifies assets are typically not reported within their present value. It is also probable that numerous brand names as well as unique merchandise lines will not be incorporated amid the assets described on the balance sheet. This, even while they may be the greatest valuable of all the articles owned by a business.

These instances are indications that financial ratios plus financial statement analysis present with limitations. In addition, it is also imperative to understand that a remarkable financial ratio within one industry a business or industry might viewed as less than extraordinary in a dissimilar industry. One organizes financial ratios plus financial statement analysis as follows:

Balance Sheet

Overall discussion

Common-size balance sheet

Financial ratios centered on the balance sheet

Income Statement

Common-size income statement

Financial ratios centered on the income statement

Statement of Cash Flows

Ratio analysis comes in various forms and is used to assess associations among fiscal statement items. The ratios help to recognize trends over time for a business or to relate two or more businesses at one point in time. When defining financial statement ratio analysis, one must focus on three main characteristics of a business: liquidity, profitability, and solvency. Liquidity ratios assist the person in measuring the ability of a business to recompense its short-term arrears and meet unforeseen cash needs. The current ratio aptly labeled the working capital ratio, acts as working capital and is the dissimilarity between existing assets and existing liabilities. This ratio enables the measurement of the aptitude of a business to pay its existing responsibilities using present assets. The current ratio is calculated through division of existing assets by existing liabilities. Financial statements, cash flows, and other things like taxes are thus important variables when performing ratio and financial statement analysis (Parrino, 2012, p. 54).

Literature Review

This literature review is meant to display ratio and financial statement analysis in real world settings and real world applications. Some are studies that show the use of ratio and financial statement analysis in real world situations. It also describes the other facets that goes into the analysis. Things like IFRS and other accountant terms will be discussed through these articles to help provide better context surrounding the topic. Some articles also provide results that support the use of ratio and financial statement analysis in prediction and estimation.

In an article explaining the use of ratios over IFRS rules, the ratios evidently specify that IFRS guidelines result in more traditional ratio results with regard to the present and long-term creditor when likened to U.S. GAAP. The article also explains every liquidity ratios is lesser under IFRS also the variances are noteworthy. Likewise, all long-term ratios lend towards more conservative when likened to U.S. GAAP. The insinuations here is that the rules of IFRS will have far grander undesirable implications on things like bond covenant agreements including other short- and long-term creditor lawfully binding agreements than U.S. GAAP.

IFRS represents the future of international financial reporting and must be involved as a foremost part of any accounting and/or corporate prospectus in the United States, including the rest of the world. "This case illustrates a situation where a Balance Sheet and Income Statement is prepared using GAAP as a basis and converting to IFRS for comparison purposes, with the focus being from the creditor point-of-view" (Harris, Stahlin, Arnold & Kinkela, 2013, p. 49). So essentially, the case study examined and discussed the rules of as well as key Lease accounting comparisons and differences amongst GAAP and IFRS. In addition, they addressed its consequences on the company's creditors. This article shows just how important certain aspects of accounting are when dealing with ratios and analysis.

In another article by Daniel & Ionut, the costumer receivables gathering period shows a progressive connection to the bankruptcy prospect in the projected model, which proposes that higher bankruptcy prospects are connected to the businesses with high costumer receivables gathering periods. "The fixed assets ratio, the fixed assets turnover ratio, the equity working capital and the autonomy ratio showed negative correlations to the estimated probability of bankruptcy, which suggests that high values of these ratios are associated with low bankruptcy probabilities" (Daniel & Ionu? 2013, p. 983). Analyzing ratios in this article shows how one can predict bankruptcy probabilities.

For one to validate properly the model within a spatial out-of-sample base, the businesses from the target populace were selected randomly and split in two approximately equal groups:

estimation group (2165 companies) and validation group (2162 companies)."The model generated through logistic regression offers an in-sample overall 70.3% accuracy in the prediction of the bankruptcy event, with an out of sample overall accuracy of 67.6%. The accuracy rate on validation sample rises slightly to 67.9% if Ewc2 is added" (Daniel & Ionu? 2013, p. 983). These calculations show real world use of ratios in terms of predicting outcomes and behaviors within a business setting. Ratio analysis, financial statement analysis, enables a better understanding of the current condition within the business and helps see the future. The future always has innumerable possible outcomes. Ration analysis in this instance, narrows the gap.

Gosman & Ammons write an article discussing real world interactions of people within their workplace and their guesses on DSAR. Jill was one employee mentioned. She had predicted, she and her other coworker Bob, were astonished by the very small DSAR for their store Macy's and the substantial (57-day) variance amid the two department stores. "Bob suggested that they re-cheek the EDGAR data for Macy's and then recalculate the ratio. Unfortunately, this step did not resolve their dilemma as they determined that the data initially used and the DSAR calculation that they had made were accurate" (Gosman & Ammons 2013, p. 3). When they recalculated the ratio, they saw the differences and were able to gain a more accurate assessment.

Ratio and financial statement analysis enables higher rates of accuracy. Accuracy remains an important element in any business. A business like Macy's relies on accuracy as inventory and sales are numerous. It is a big chain department store with many employees. Things must be kept in track of, especially financials. That is why ratio analysis becomes an indispensable tool.

A study examined the economic status of unstable university hospitals. They did so through evaluating if they did or did not meet financial standard ratios. Their general results demonstrated that the financial standing of several of the university hospitals were and remained unstable. This was seen through examination of the many financial indicators that these hospitals failed to meet in terms of financial standard ratios. Only eight financial indicators of the sum of nineteen indicators fulfilled financial standard ratios.

The results of financial statements analysis suggest that nurse managers should develop the blue ocean strategy for diversification of nursing services to improve financial ratios of liquidity, performance, and growth.… [END OF PREVIEW]

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