Users of financial statements can apply several analytical tools in order to mak

Question

Users of financial statements can apply several analytical tools in order to make intracompany and intercompany comparisons related to balance sheet information. Common-size analysis, rate of change analysis, and various ratios can be used to evaluate information on the balance sheet. Choose at least one analytical tool and discuss it in detail. Explain what the tool measures. Describe the steps involved in using the tool. Discuss the usefulness of the information that the tool provides the user. What are the pros and cons associated with the measure? Are there better ways to measure the performance under review? Do you agree with the pros and cons they have presented? Is there a better way to analyze the performance measurements they have chosen

Explanation / Answer

The tool I am discussing hereunder is Liquidity and Current Ratio.

Liquidity measures the ability of a company to turn its assets into cash. One of the tools to measure liquidity is the current ratio. The current ratio divides a company’s current assets bytheir current liabilities. A company should have more current assets than they have current liabilities. An accepted current ratio has a value greater than one,this means that the company has more than one dollar of asset to cover one dollar of liability.

Current ratio suggests that company whether have more current assets or less current assets than their current liabilities. It is advisable to have current ratio of 1.50, though it varies from industry to industry.

The major advantage of current ratio are that it is easy to use,provides benchmark data to measure the position of current assets to currernt liabilities. However the major limitiation of this is too much dependence on the quantative data only. Sometimes performance is also effected by the qualitative factors like fire in the stock which can imbalance the ratio.

Yes, there are many tools which can be better at times in analysing performance. Pros and Cons given above do exist and i agree with them.

There ar many tools like horizontal analysis, vertical analysis, trend percentage anayalysis which can be used for the performance measurement.

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