Section 2: Financial Ratio Analysis [WLOs: 1, 2] [CLOs: 1, 2]
Ratio analysis provides another set of patterns to evaluate before deciding to buy or sell a company’s stock. Ratios reveal more than just the past performance; ratios reveal how effectively the company converts product sales into shareholder returns. Ratios provide a gauge for comparison across time and across the industry (competitors), while removing the impact of size differences. Would you rather invest in Company A, with $1.0 million in earnings, or Company B, with $10.0 million in earnings? It’s hard to say. However, if Company A earns a ROA of 25%, while Company B earns a ROA of 2%, the decision becomes clear.
Liquidity ratios provide clues to how effectively the company manages its cash collection cycle. Asset turnover ratios reveal how efficiently the company uses its assets to generate profits. Debt management ratios reveal how leveraged a company is, which provides an indication of future risk. Taken together, a company’s ratios and its ratios compared to the industry competitors provide important insight to the investment strength of the company’s stock. In this assignment, you will review the trend in your chosen company’s financial ratios over the past 3 years and compare your chosen company’s ratios to the average ratios from top competitors in the industry.
Prior to beginning work on this assignment,
In your paper, address the following four parts in a Word document:
Part 1: (three to five paragraphs)
- Summarize the trends in your company’s ratio performance over the 3 most recent years. Be sure to address the following ratios included in Appendix C:
- Profitability ratios: ROA, ROE, return on investment (ROI).
- Liquidity ratios: quick ratio, current ratio.
- Debt management ratios: long-term debt to equity, total debt to equity, interest coverage ratio.
- Asset management ratios: total asset turnover, receivables turnover, inventory turnover, and accounts payable turnover.
- Per share: book value per share.
Part 2: (two paragraphs)
- Interpret whether the trend for each ratio (listed in Part 1) is an improvement or a decline in performance for the company.
- Create a table that lists each ratio as either a strength or a weakness in the most current year, based on its trend and your interpretation.
- Determine the overall financial strength of the company based on the ratios identified as either strengths or weaknesses.
- Consider all of the ratios discussed so far. Is the company’s strength the fact that the debt management ratios are improving? Or is it that the liquidity ratios are increasing? Is the company’s weakness that the turnover ratios are declining? Or is the company’s weakness that debt management ratios are weakening?
- Categorize the company’s overall ratio performance as either strong, neutral, or weak, based on your determination from the ratios.
Part 3: (one to two paragraphs)
- Compare your chosen company’s ratio performance to the industry competitor ratios in the most recent year based on Appendix D. Be sure to address the following ratios included on Appendix D:
- Profitability ratios: ROA, ROE, gross margin, and net margin.
- Liquidity ratios: quick ratio and current ratio.
- Debt management ratios: long-term debt to equity, total debt to equity, and interest coverage ratio.
- Asset management ratios: asset turnover and inventory turnover.
- Create a table that lists each ratio as either higher or lower than the average ratio for the competitors in the industry.
Part 4: (one paragraph)
- Categorize the company’s overall financial performance as either better than average, average, or worse than average compared to the industry based on the ratios.
- Interpret which ratios are the most important and explain your reasoning.
- Justify your conclusion based on the table you created, your interpretation of which ratios are the most important, and the company’s overall ratio performance compared to the industry competitors.
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The Section 2: Financial Ratio Analysis paper
Note: Since this is Section 2 of the Week 5 final project, there is no need for an introduction paragraph.
Carefully review the Grading Rubric (Links to an external site.) for the criteria that will be used to evaluate your assignment.