Financial Statements Are Prepared Primarily For Decision Making Finance Essay - Free Essay Example

Financial statements are prepared primarily for decision-making. The information provided in the financial statements is of immense use in making decision through analysis and interpretation of financial statements. Financial analysis is a process of synthesis and summarization of financial operative date with a view to getting into an insight into the operative activities of business enterprises. It is the process of identifying the financial strength and weakness of firm by properly establishing relationship between the items of balance sheet and profit and loss account. Ratio Analysis: Ratio is an expression of the quantitative relationship that exists between the two numbers. In simple language, ratio is one number expressed in terms of another and can be worked out by dividing one number in to the other. It shoes an arithmetical relationship between two figures. The ratio may also be expresses in the form of percentage, which can be obtained by multiplying the quotient by 100.for example Net Profit Ratio=30%, return on capital=12%etc. Significance of Ratios Analysis: The ratio analysis is one of the most powerful tools of the financial analysis. The ratios are easy to calculate. Ratio analysis makes for easy understanding of financial statements. With the use of ratio analysis one can measure the financial condition of a firm and can point out whether the condition is strong, good, questionable or poor. Ratios act as an index of the efficiency of the firm. Two or more accounting groups is called financial ratio. Its helps to summarise a more mass of financial data into concise and make accurate interpretation and conclusion the performance and status of the firm The most important and commonly adopted classification of ratios is on the basis of the purpose or function, which the ratios are expected to perform; such ratios are called Functional Ratios. Below are the ratios we are using for the given assignment Profitability Gross Profit Ratio (%) ÂÂ   2008 2009 2010 Gross profit Ratios( % ) 20 16.67 14.94 By looking at the above figures for 2008, 2009 and 2010. Year 2008 has a good percentage of profit when comparing to 2009 and 2010. Operating Profit Ratio (%) ÂÂ   2008 2009 2010 Operating profit Ratios (%) 80 83 85 This ratio establishes the relationship between the cost of sales and sales revenue. The above ratios indicate the continuous increment in operating expenses. In 2008 operating expenses are 80% and in 2010 it goes up to 85%. As the high operating ratio would leave a small margin to cover or meet financial expenses. Net Profit Ratio (%) ÂÂ   2008 2009 2010 Net Profit Ratios (%) 10 8.7 7.7 As the above figures indicates that year 2008 has a good ratio of 10% and a decrease in 2009 and 2010. Return on capital employed (%) ÂÂ   2008 2009 2010 Return on Capital employed Ratios. 0.50 0.52 0.56 The profitability of the firm can be analysed from the point of view of the total funds employed in the firm. The higher the ratio return on capital employed the more efficient has been the use of capital employed. One can see that the return on capital in the year 2010 is much higher than in the year of 20082009. Liquidity: Current Ratios ÂÂ   2008 2009 2010 Current Ratios. 3.75 2.99 3.27 The current ratio is a measure of the firms short-term solvency. It indicates the availability of current assets in pounds for every one pounds for current liability. The above statement shows in the year 2009 and 2010 has doing much better in this ratio. Quick Ratios ÂÂ   2008 2009 2010 Quick Ratios. 3.31 2.55 2.67 Quick ratio is considered to be the better test of liquidity than Current ratios. In 2008 we holds a very good stock compares to 2009 and in again in 2010 we are holding a very good stock. Asset Utilisation and Efficiency: Total Asset Turnover Ratio ÂÂ   2008 2009 2010 Total Asset Turnover Ratios. 4.05 4.45 4.08 A lower ratio in 2008 indicates the utilization under of assets. 2009 indicates the over trading compare to 2010. Fixed Asset Turnover Ratio ÂÂ   2008 2009 2010 Fixed Asset Turnover Ratios. 13.60 20.51 26.07 As the above figure indicates idle capacity in 2008 while over trading in 2009 and 2010 to investment in Fixed assets. Current Asset turnover Ratio ÂÂ   2008 2009 2010 Current Asset Turnover Ratios. 5.76 5.68 4.84 This ratio indicates the extent to which the investment in current assets contributed towards sales. The figures indicates that 2008 and 2009 excessive invested in current assets while in 2010 it is low ratio capacity. Working capital turnover Ratio ÂÂ   2008 2009 2010 Working Capital Turnover Ratios. 7.86 8.53 6.97 In 2009 we has a very good utilisation of working capital comparing to 2008 and 2010 retained with low utilisation of working capital. Inventory turnover Ratio ÂÂ   2008 2009 2010 Inventory turnover Ratios. 77.49 42.38 29.87 The Stock turnover ratio shows how many times over the business has sold the value of its stocks during the year. By looking at the figures mentioned in the above table, we can conclude that turn over rate has fallen down from 77.49 to 29.87 Fixed assets to Net worth Ratio ÂÂ   2008 2009 2010 Fixed Asset to Net worth Ratios. 0.89 0.79 0.72 This ratio indicates the percentage contributed by owner to the value of fixed assets. a ratio at least 1:1 is considered desirable on other hand, lower ratio suggest an undue burden on debt on the enterprises that tends to increase the internal rates at which an enterprise can borrow. 14 12