Business & Finance Homework Help| Business & Finance homework help
You can use financial ratios to measure the performance of an enterprise over time. Financial ratios such as the debt-to equity ratio and return on asset are common. The current ratio is calculated by dividing current assets by current liabilities in order to measure a company’s liquidity. A high ratio shows that a business is able to meet short-term commitments while a lower one could indicate possible solvency problems.
Debt-to-equity ratio (D/E), measures the debt of a business in relation to equity or shareholder capital. An increased D/E indicates greater risk to investors, since it shows that the company relies heavily on borrowing money rather than internal resources.
The return on asset (ROA), meanwhile, measures the profitability of a firm in comparison to its entire assets. This gives an indication as to how effectively management manages operations and uses resources.
If you compare two years, make sure to take note of any ratio changes from year to year and determine what effect they may have had over the course of time. For example, if a business’s ROA falls from 10% in 2013 compared 11% in 2014 even though total assets increased during the same period, then this could suggest underlying efficiency problems associated with increasing asset utilization rates. Also, changes to the leverage or liquidity positions of a business should be carefully monitored. They could signify upcoming problems such as cashflow shortages or excessive risks.
Financial ratio analysis across several years provides valuable insights into the trends that have developed over time. This helps practitioners to make more informed decisions regarding investments and mergers or acquisitions.