How companies use financial ratios to evaluate performance

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Financial ratios (also called financial indicators) are factors that are used to evaluate accounting
and financial units. Through which the relationship of each of two direct financial data analyzes
current or past state of an organization, according to optimal levels defined for it.

They serve as the basis for decisions (problem identification, identification of operational
vulnerability, information extraction), control (target / actual comparison), documentation and/or
coordination (behavioral control).

Financial ratios are calculated on the basis of two or more numbers from financial statements of
companies. These numbers can be obtained from the balance sheet or income statement. Less
often they can be derived from the changes in equity or cash flow statement.

These ratios are used by debt issuers to analyze credit risk, company executives to assess staff
performance (stock options) or projects. And stock market investors that try using the
fundamental analysis to select securities with better prospects.

The ratios quantify many aspects of the business, but should not be used individually without
considering the financial statements. Rather, it should be an integral part of the analysis of
financial statements. The application of a ratio yields insights which come from a deeper
analysis of events around the company.

Ratios enable you to make comparisons among companies, some sectors (eg, banking and
petrochemicals), in different periods of time. As a relative indicator, two selected variables are
placed in an appropriate relation to each other. Key figures provide condensed information.

Financial ratios are published in part by the companies themselves. The exact calculation of key
figures in most cases is not standardized. So many key figures depend on the underlying
accounting rules that differ internationally. A comparison of companies of different countries is
therefore only conditionally possible.

Ratios which are related to each other can be combined into performance measurement
systems. Known systems are the DuPont performance measurement system, and the
ZVEI-RL-indicator system.

Of special significance are key figures in the comparison as well as operating in the so-called
benchmarking. The key figure of the 'best company' represents the benchmark (or best
practice), which other companies may want to emulate.

Ratio of total debt on Investment measures the magnitude of borrowing or financing, within the
total funding (consisting foreign funds and capital). And the formula is (Current Liabilities + Long
Term Liabilities) * 100) / Total Assets = (PC + PLP) * 100) / AT.

Figures can be divided fundamentally into absolute and relative indicators.

    - Absolute figures: Their information content is defined by the significance of the value itself,
such as cash flow, gross margin, EBIT. They comprise of individual values, totals, and average
values.
    - Relative figures: the connection of two managerial levels of a key figure with elevated
and/or specific significance
The relative strength of an index depends primarily on the factual context of the compared
quantities.

				
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