Significance of Financial Ratio: Essay Sample

Introduction

A sustainable business and goal desire effective financial management and planning. Ratio analysis is an important management tool, which will enhance one’s understanding of financial outcome and tendencies over time, and offer a crucial signal of organizational performance. May utilize ratio analysis to measure the company results against its competitors or make judgments regarding management effectiveness. This essay aims to analyze factors affecting financial ratio, use, and limitation of financial ratio.

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Factors affecting Financial Ratio

There is no way to different companies' ratio analysis, mainly if they are operating in different industries. Several factors are affecting the financial ratio. For instance, these aspects usually affect how ratios, such as return capital and debt to equity on capital, should be analyzed. Small companies pay more for their debt than large firms, which affects how the interest coverage ratio is calculated. Apart from the size of factors are market sentiment and shift in company destiny.

Comparison of Adidas and Nick Financial Ratio

According to Wright (2019), Nike's current ratio is 2.27, which is almost double of Adidas. While the quick ratio of the two companies is almost the same with a value of 1.71 and 1.10 respectively, only that for Adidas, inventories need to be deducted from the current asset (Wright, 2019). Adidas has a broader product stock that is not selling as fast as Nick's from these financial ratios.

Benefits and Uses of Financial Ratios

The preparation of a budget needs a comprehensive understanding of the company's previous year's financial picture. Correct budget a company can be obtained by referring to the historical financial statements. Joined together with a revenue prediction, the previous year’s expenditure will assist one to prepare a correct budget (Nadar & Wadhwa, 2019). The financial statements will further help determine the essential ratios that will mirror the firm's well-being and point opportunities for advancement. Further, the debt-to-equity ratio is essential, as is the inventory turnover ratio.

Besides, ratio analysis is extensively utilized as a powerful element of financial statement analysis. Financial ratio formulates the numerical relationship between two aspects of a financial statement to discover current financial potion and the shortcoming and strongholds of a company. Such information is vital to unstressed parties since it aids them in making an appraisal of a particular element of an organization's performance.

Limitation of Financial Ratio

Arkan (2016) pointed out that ratio analysis depends purely on data found in a company’s financial statements. Some firms may defectively make their company look better by manipulating the data in their financial statements. The act of manipulating data is against financial and business ethics and can land an organization into facing charges against corporate governance.

Utilizing mathematical ratios to a company's financial statement can help an organization generate a perspective of how it works and alert it to potential trading and investing chances. However, it has some limitations. One such other companies may choose to distort their balance sheet by inflation. A financial ratio is a valuable tool for financial analysis. A business owner should consider such a limitation when comparing his business with that of its competitors.

References

Arkan, T. (2016). The importance of financial ratios in predicting stock price trends: A case study in emerging markets. Finance, Rynki Finansowe, Ubezpieczenia, (79), 13-26. https://www.ceeol.com/search/article-detail?id=623339

Nadar, D. S., & Wadhwa, B. (2019). Theoretical Review of the Role of Financial Ratios. Available at SSRN 3472673.

Wright, M. (2019). Strategic Audit of Adidas. https://digitalcommons.unl.edu/cgi/viewcontent.cgi?article=1160&context=honorstheses