Financial Ratios

1. Which of the following are sources of funds and which are uses of funds?

Following are the Source of Funds:

 

a)      Sale of land

b)      Decrease in raw materials inventory

c)      Sale of government bonds

Following are the Uses of Funds:

a)      Dividend payments

b)      Decrease in accrued taxes

c)      Depreciation charges

2. Why do short-term creditors, such as banks, emphasize balance sheet analysis when considering loan requests? Should they also analyze projected income statements? Why

Banks emphasize balance sheet analysis because, balance sheet is the listing of all assets and liabilities of a person or a company in order to arrive at a net worth. Which is the difference between the assets and the liabilities? Most lenders require a balance sheet as part of the loan application process. Short-term debt, which will be paid off in one year or less, is treated by lenders in a different manner than long-term debt when calculating their various ratios to determine loan eligibility. As a result, consumers would be well advised to separate the two types of debt when completing a balance sheet form provided by the lender.

They should also analyze the projected income statement because it will ensure the bank that the company is in profit and growing. If the projected income statement shows the losses then bank will refuse to give the credit. It will show the profitability of the company and on the basis of this analysis bank will decide.

3. Which financial ratios would you be most likely to consult if you were the following? Why?

a)            A banker considering the financing of seasonal inventory

Liquidity Ratios (such as Debt to Equity) 

This ratios will shows the cash and ready to cash, A bank will finance only if bank has the sufficient cash balances and he can also financing the seasonal inventory if bank feel that it has the most liquid assets, and would be the most likely to be used to cover short-term debts in an emergency.

b)           A wealthy equity investor

Valuation Ratios

 Such as Price/Earnings and Profitability Ratios (such as Profit Margin)

These ratios show the profitability of the stock, what the profit margin of the stock is and what are the price earnings ratios. These ratios will help him to decide which stock is to be purchase or not to purchase.

c)            The manager of a pension fund considering the purchase of a firm’s bonds

Liquidity Ratios (such as Debt to Equity) 

Because debt to equity ratios shows the ability of firm to pay its debts and before buying the bonds he will insurance whether firm can pay the debts and on the basis of this ratio analysis he will decide whether to purchase or not to purchase.

d)           The president of a consumer products firm

Activity Ratios (such as Inventory Turnover)

A ratio showing how many times a company's inventory is sold and replaced over a period. This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying. High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall.