A ratio is one value expressed to another. A financial ratio is one financial va

Question

A ratio is one value expressed to another. A financial ratio is one financial value or measurement expressed to another. There are about 20 financial ratios commonly used to assess one company's performance compared to another company in the same industry, or to itself over time.

Why or why not do you consider it sound business practice to make financial decisions based solely on the results of calculating financial ratios, for instance, whether to invest in a company or loan money to it?

Is it possible that a "good" financial ratio might be artificially caused by another ratio which is "bad"?

Explanation / Answer

I would not make a financial decision based on ratios only. Though i beleive ratios are a good way of comparing different aspect of a company whether internal or when compared to other companies. Ratio does not provide a complete picture of any company, however it sheds light on different aspects of a company's performance or efficiency. e.g. a high current ratio states that the company has good liquidity but does not give information about its profitability.

Manipulation of financial ratio is possible. The profit ratios can be manipulated by including one time gains or pre recording revenue to increase the profit of a particular period. Similarly the ratios can be negativily manipulated by increased expenses or one time charges or delaying in recording revenues.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.