Many financial ratios can be utilized to analyze financial statements. These fall into four...

Question:

Many financial ratios can be utilized to analyze financial statements. These fall into four primary categories. Many financial analysts tend to utilize one or two of the following ratio categories when evaluating a company: Liquidity Ratios, Activity Ratios, Profitability Ratios, Coverage Ratios.

Imagine that you are a financial analyst. Discuss the ratios you would most likely focus on when you conduct your analyses. Provide a rationale for your answer.

Ratios:

Ratios can be simplistic or complicated calculations of balance sheet and income statement comparisons to fully understand the trends of an enterprise. Ratios can be financial or non-financial.

Answer and Explanation:

The two areas I would normally focus on as a financial analyst in a financial institution are liquidity ratios and coverage ratios. Liquidity ratios such as working capital, current, and acid test "quick" ratios allow an analyst to determine a company's ability to service its current obligation. Working capital ratios should be positive and current and quick ratios should be in excess of 1x. A current ratio and/or quick ratio indicates insufficient current or most liquid current assets are available to service current obligations. A current ratio of less than 1:1 will also produce a negative working capital.

Coverage ratios report the leverage-positive of a firm. An elevated debt to worth/equity ratio indicates that a firm may have difficulty serving its debt obligations in the event of a downturn.