What to Measure The first consideration is what to measure. These are the major categories: 1 Short-term Liquidity
2 Profitabilty on Revenue
3 Return on Investment
4 Long-Term Solvency
5 Market Ratios There are 5 categories to measure and 10 ratios to select. That is an average of about two ratios per category The 10 ratios below are those I would pick if I was asked for the 10 most significant ratios. Ten Key Ratios Short-term Liquidity
1 Quick Ratio Profitabilty
2 Average Annual Revenue Growth
3 Gross Profit % to Revenue
4 Operating Profit (or EBIT) % to Revenue Return on Investment
5 Net Income from Continuing Operations/Total Common Equity Long-Term Solvency
6 Interest Coverage (EBIT/Interest Expense)
7 Long-Term Debt to Total Common Equity Market Ratios
8 Beta
9 Common Stock: Market to Book Value
10 Price:Earnings Ratio1 Numerical values of each ratio for both of your two companies should be provided in your answers.
What Makes Financial Ratios Important? There are many reasons for using financial ratios. Here are some important reasons: 1) Organization managements need to evaluate their performance in order to gain - or at least retain - their efficiency and effectiveness and to meet or beat their goals. Ratios measure organizational efficiency and effectiveness, and whether goals have been achieved - or exceeded. 2) Ratios measure absolute period performance for a given organization for a stated period. But equally important is performance of the organization in relation to: a. Its own performance in past periods. This comparison reveals trends over time. b. Performance of a similar organization (or competitor) for the same period. This reveals performance compared with a peer organization. c. Performance of a group of similar organizations (such as an industry composite) for the same period. This reveals performance compared with a peer group. 3) Organizations are of different sizes. Even the same organization may grow or shrink in size from one period to another. So dollar comparisons are affected by organization size. In order to eliminate size differences and to make valid comparisons, we use ratios - which are independent of size. So ratios allow us to compare organizations of all sizes. 4) It is not just organization managements that need to evaluate organization performance. Other parties that need to evaluate organization performance include: a. Customers of the organization concerned, who wish to know how dependable a supplier the organization may be. b. Suppliers to the organization concerned, who wish to know how dependable a customer the organization may be. c. Employees of the organization concerned, who wish to know how dependable an employer the organization may be. d. Independent auditors of the organization concerned, who wish to know how dependable the financial reporting of the organization may be. e. Investors (actual and potential) in the organization concerned, who wish to know how safe, risky and profitable the
