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:

You work for a brokerage firm. Your boss asked you to analyze Blue Parrot Manufacturings performance for the past three years and to write a report that includes a benchmarking of the companys performance.

Which of the following components would be best for you to include in your financial statement analysis?

A critique of the companys financial statements and a report of any misprints to be sent to the Securities and Exchange Commission

A calculation of financial ratios and an evaluation of the comparative trends in the firms financial position and performance over a certain time period

Most decision makers and analysts use five groups of ratios to examine the different aspects of a companys performance. Indicate whether each of the following statements regarding financial ratios are true or false?

Statement	True	False
A company exhibiting a high liquidity ratio means it is likely to have enough resources to pay off its short-term obligations.
Asset management or activity ratios provide insights into managements efficiency in using a firms working capital and long-term assets.
Debt or financial leverage ratios help analysts determine whether a company has sufficient cash to repay its short-term debt obligations.
One possible explanation for an increase in a firms profitability ratios over a certain time span is that the companys income has increased.
Market-value or market-based ratios help analysts figure out what investors and the markets think about the firms growth prospects or current and future operational performance.

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.

A firm may operate in multiple industries.

Different firms may use different accounting practices.

A firms financial statements show only one period of financial data.