Usefulness of Ratios analysis
· to forecast furture earings and cash flows
· understand the financial flexibility of the firm
· evaluate management's performance
Examples:
· Premium and custom products is at higher gross maring
· Higher proportion spent on research and development leads to our expectation of products with cutting-edge features and high quality.
· Larger ratio of gross profits to operating profits if spend more in R&D and/or advertising expenditures.
· Examine if the company has implement their claimed strategies such as cutting cost
Limitations of ratios analysis
· cannot useful if viewed in isolation;
· difficult comparison due to different accounting treatment;
· difficult to find comparable industry ratios for multi-operations company;
· All ratio but not only one set of ratios must be viewed relative to others for conclusion
· Difficult to find a meaningful set of industry-average ratio for multi-operations company
· Seasonal factors distort ratio analysis
· Different accounting practices
· Difficult to generalized about wheter a ratio is good or not
· Difficult to tell if the company is good or weak due to the combination of good and bad ratios
· Require to judge some range of acceptable values
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