10. Analyzing ratios

One of the most important applications of ratio analysis is to compare a companys performance with that of other players in the industry or to compare its own performance over a period of time. Such analyses are referred to as a comparative analysis and trend analysis, respectively.

A common size analysis requires the representation of financial statement data relative to a single financial statement item (or base account or value).

What is the most commonly used base item for a common size balance sheet?

Net sales

Net income

Earnings before interest and taxes

Total assets

Suppose you are conducting an analysis of the financial performance of Blue Hamster Manufacturing Inc. over the past three years.

The company did not issue new shares during these three years and has faced some operational difficulties. The company has thus pilot tested some new forecasting strategies for better operations management. You have collected the companys relevant financial data, made reasonable assumptions based on the information available, and calculated the following ratios.

	Ratios Calculated
	Year 1	Year 2	Year 3
Price-to-cash-flow	2.80	1.96	1.57
Inventory turnover	5.60	4.48	3.58
Debt-to-equity	0.60	0.48	0.38

Based on the preceding information, your calculations, and your assumptions, which of the following statements can be included in your analysis report? Check all that apply.

Blue Hamster Manufacturing Inc.s ability to meet its debt obligations has improved since its debt-to-equity ratio decreased from 0.60 to 0.38.

A decline in the inventory turnover ratio can be explained by the new inventory management system that the company recently adopted, which led to more efficient inventory management.

A decline in the inventory turnover ratio could likely be explained by operational difficulties that the company faced, which led to duplicate orders placed to vendors.

A decline in the debt-to-equity ratio implies a decline in the creditworthiness of the firm.