Financial ratios are essential to provide an accurate valuation of a firm. Selec

Question

Financial ratios are essential to provide an accurate valuation of a firm. Select a publicly traded firm of your choice. You may use the firm you have elected to profile for the course-long Financial Analysis and Proposal assignment or a completely different organization altogether. Select one ratio each in the areas of (a) performance, (b) activity, (c) financing, and (d) liquidity warnings. Provide an evaluation of the selected firm's strengths and weaknesses. Based on the ratios you selected, how well does your chosen firm perform? Explain.

Explanation / Answer

Solution:

Financial ratios are very important to gauge the performance of a company. There are four major financial ratios i.e. Profitability(Performance), liquidity, solvency(financing), and efficiency(Activity). There are many ratios in these four, for example, liquidity ratio has the current ratio, quick ratio, and cash ratio.

The public company that has been chosen is Microsoft and data taken from yahoo finance.

Note: All the numbers are in thousands and data are for year 2017

1. Performance

Net profit margin = Net profit / revenue

Net profit = 21,204,000, Revenue =  89,950,000

Net profit margin = 21,204,000 / 89,950,000 = 23.57%

Evaluation: Net profit margin is 23.57% which is very good number and it shows that company is generating good amount of profit on sales.

2. Activity

Total asset turnover = Net sales / Average total asset

Net sales = 89,950,000, Total asset (2017)= 241,086,000, Total asset (2016)= 193,468,000

Average total asset = (241,086,000 + 193,468,000) / 2 = 217,277,000

Total asset turnover = 89,950,000 /  217,277,000 = 0.414

Evaluation: Total asset turnover is 0.41 which is reasonable considering that the company has high current asset in terms of short term investments and it is a good sign that these current assets can be used at the time of acquisition and other financial needs

3. Financing

Debt to equity ratio = Total debt / Shareholder's equity

Total debt = Long term debt + short term debt =76,073,000 +10,121,000 = 86,194,000

Equity = 72,394,000

Debt to equity = 86,194,000 /  72,394,000 = 1.19

Evaluation: The company has reasonable debt to equity ratio of 1.19 and since the company has high profit margin there is no worry for the payment of debt in forseable future

4. Liquidity ratio

Current ratio = current asset / current liability

Current asset = 159,851,000

Current liability = 64,527,000

Current ratio = 159,851,000 / 64,527,000 = 2.48

Evaluation: If current ratio is more than 1 then it is good for the company and here Microsoft has 2.48 which means that the compny has enough current assets to meet the current liability and there is no liquidity issues

If we see the overall strength of the firm then we can say that the company has good profitability and liquidity ratios and on a weakness side the debt of the company is relatively high though this is not a cause of concern

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