# Ratios Analysis Essay

Published: 2020-01-19 21:51:01
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The relationship between two variables is defined by ratios. When dividing the dollar amount of one item on a financial statement by the amount of another item on the financial statement a financial ratio is computed. Expressing the relationship of two variables for ease of comparison and interpretation of other information is the purpose of ratio analysis. A ratio analysis computation allows a look at a particular time period in a financial statement. Ratios present a true picture of a companys financial health, which serves as a control. In analyzing a business one would want to know if enough funds are being generated, if there is a chance of the company defaulting on obligations, if the company assets were being utilized properly and if there were projected short term and long term cash flow positions. To answer some of these questions several ratios related to the assets, liabilities, revenue, and expense categories on a financial statement will be evaluated.

Financial Statement Category Assets

Current ratio and total debts to asset ratio are two of the ratios used to evaluate the strength, of a business. Current assets divided by current liabilities will yield the current ratio. In an example from the financial statement of the University of Chicago Medical Center (UOCMC), of June 30, 2012 and 2011 the total current assets of \$356,442 divided by the total liabilities of \$190,257 in 2012 yielded a current ratio of 1.87. A current ratio of 1.5 is considered good in most industries. As the number reaches or goes under one, this identifies the company has a negative working capital (Kennon, J. 2013). The total debt to total assets ratio identifies the companys financial risk by showing how much of the assets of a company is financed by debt. Usually the lower this ratio figure is the better off the company. The formula can be displayed by showing the total liabilities divided by the total assets. Again using the figure from the UOCMCs financial statement in 2012 the liabilities of \$1,324,494 divided by the assets of \$2,453,848 produced, a total debts to total assets ratio of 0.539.

Financial Statement Category Liabilities

When evaluating the liabilities category of a financial statement two of the ratios to use could be working capital ratio and cash ratio. Working capital ratio allows a company to manage day to day operations. This is also known as liquid assets. So by dividing the current assets by the current liabilities, this will give the working capital ratio. The 2012 current assets of the UOCMC were \$74,348 and the current liabilities were \$117,678. By dividing the current assets by the current liabilities, the working capital ratio of 0.631 was produced. A stable working capital ratio is between 1.2 and 2.0. The working capital ratio of less than one identifies a business that is not able to handle current liabilities and might be in trouble. The cash ratio indicates a companys liquidity by measuring the amount of the companys cash, cash equivalents and invested funds over their liabilities (Loth, nd.). To continue with the figures from the UOCMC in 2012, their cash and cash equivalents of \$74,348 plus invested funds of \$27,033 divided by their current liabilities of \$190,257 equaled a cash ratio of 0.53.

Financial Statement Category Revenue

Revenue ratios used to evaluate the revenue category are total margin and operating margin. The total margin ratio looks at all sources of revenue. If the ratio is high the company is considered to costs in control while making a profit. Net income divided by total revenue is the formula to calculating the total margin ratio. In our example of the UOCMC in 2012 the net income of \$1,221,971 divided by \$1,289,885 equaled a total margin ratio of 0.94.

The operating margin measures managements efficiency by comparing competitors to the companys activity. A company is doing better than others in the industry if, its operating margin is higher (Kennon, J. 2013). To determine this ratio the operating income minus total operating expenses are divided by the total operating revenue. In 2012 the UOCMCs total operating revenue of \$1,289,885 minus the total operating expenses of \$1,170,723 divided by the total operating revenue of \$119,162 equaled the operating margin of 1.

Financial Statement Category Expenses

The expenses category is evaluated by calculating the operating expense ratio and the depreciation expense ratio. The operating expense ratio measures the financial efficiency of a company in how it is able to generate income (Kantrovich, 2012). The formula for this ratio is the total operating expense not including interest minus depreciation divided by gross income. In 2012 the total operating expense of \$1,170,723 minus the depreciation of \$67,522 divided by gross income \$1,289,885 equaled 0.85. The depreciation expense ratio indicates the amount on revenue required to sustain the capital that is used by the company. A lower the depreciation-expense ratio displays a better condition of the company. This ratio is calculated by dividing the depreciation of \$67,522 by the gross income of \$1,289,885 to obtain the depreciation-expense ratio of 0.22.

Conclusion

There are many ratios to analysis the financial viability of a company, and its operations. These ratios are used in relation to the categories of assets, liabilities, revenues and expenses on a company financial statement. Several ratios have been examined. Many of them would be used by investors, stakeholders, internal and external auditor to make financial decisions, and decisions of operation. Clearly understanding what they are, and their use must be established to make sound decisions for the future of any company.

References
Kantrovich, A. (2012). Financial Ratios Part 18 of 21: Operating-Expense Ratio. Retrieved from website: http://msue.anr.msu.edu/news/financial_ratios_part_18_of_21_operating_expense_ratio Kennon, J. (2013). The Current Ratio, Investing Lesson 3 Analyzing a Balance Sheet.

e-operating-margin.htm Loth, R. (ND). Liquidity Measurements Ratios: Cash Ratio. Retrieved from website:

http://www.investopedia.com/university/ratios/liquidity-
measurement/ratio3.asp#axzz2KkXwd5IO
Priceswaterhousecooper. (2012). The University of Chicago Medical Center Financial
http://www.uchospitals.edu/pdf/uch_032798.pdf
Vazquez, W. (2010). Working Capital Ratio What it is and the Importance of Working Capital Management. Retrieved from website: http://voices.yahoo.com/working-capital-ratio-importance-5183563.html

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