1. Ratio analysis

A company reports accounting data in its financial statements. This data is used for financial analyses that provide insights into a companys strengths, weaknesses, performance in specific areas, and trends in performance. These analyses are often used to compare a companys performance to that of its competitors or to its past or expected future performance. Such insight helps managers and analysts improve their decision making.

Consider the following scenario:

Your boss asked you to analyze Green Hamster Manufacturings performance for the past three years and prepare a report that includes a benchmarking of the companys performance. Using the companys last three years of financial reports, youve calculated its financial ratios, including the ratios of Green Hamster Manufacturings competitorsthat is, comparable ratios of other participants in the industryand submitted the report.

Along with calculating the ratios, what else is needed for your report?

Making observations and identifying trends that are suggested by the ratio analysis

Identifying the factors that drive the trends in the ratios

Both of the above

There are several groups of ratios most decision makers and analysts use to examine different aspects of a companys performance. Based on the descriptions of ratios listed, identify the relevant category of ratios.

	Ratios that help determine whether a company can access its cash and pay its debts that mature in less than a year are calledliquidity ratios.
	These ratios, which help determine how efficiently a firm is using its assets to generate sales are calledasset management or activity ratios.
	Ratios that help assess a companys ability to service the interest and repayment obligations on its long-term debt and the degree to which it uses borrowed versus invested financial capital are calleddebt or financial leverage management ratios.
	Profitability ratios help measure a companys ability to generate income and profits based on its invested capital.
	Market value or market based ratios examine the market value of a companys share price, its profits and cash dividends, and the book value of the firms assets and relate them to other data items to determine how the firm is perceived in the stock market.

Ratio analysis is an important component of evaluating company performance. It can provide great insights into how a company matches up against itself over time and against other players within the industry.

However, like many tools and techniques, ratio analysis has a few limitations and weaknesses.

Which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply.

Inflation can distort balance sheet data.

A firms ratios can lead to conflicting conclusionssome ratios might be good and some bad.

Ratio analysis is conducted using benchmarking techniques.