Chapter 20 discusses the importance of ratios for understanding a company’s financial statements. Using the example of Sunbeam, which achieved profit growth by laying off employees and selling factories, demonstrates how accounting tricks can make a company look more profitable than it actually is (Tay, 2019). The author informs about different ratios and their implementation. Chapter 21 focuses on profitability, which evaluates the company’s ability to generate profits. The methods of their calculation and formulas are described, as well as their application and usefulness for specific cases. Chapter 22 concentrates on leverage ratios that allow seeing how the company uses debt. In business, leverage is usually defined as operating leverage and financial leverage, but regardless of the type, it allows the company to make more money but at the same time increases risk. The key ratios that chapter focuses on are debt-to-equity which tells how much debt the company has for every dollar of equity, and interest coverage which measures how much interest the company has to pay every year relative to how much it is making. Chapter 23 is dedicated to liquidity ratios that reveal the company’s ability to meet all its financial obligations, including not only debts but payroll, payments to vendors, taxes, and others. Chapter 24 reveals efficiency ratios which allow the revealing of how efficiently key balance sheet assets and liabilities are managed. Reducing inventory or speeding up the collection of receivables has a direct and immediate impact on the company’s cash position. Key ratios discussed in the chapter are inventory days and turnover, DII, inventory turns, days sales outstanding, days payable outstanding, property, plant, and equipment turnover, and total assets turnover. Chapter 25 considers the investor’s perspective as it always informs managerial decisions. It reveals five main ratios and indicators the average investor or bondholder cares about the most. All these measures are indicators of a company’s shareholder value.
Part five toolbox discusses which ratios are most important to a business. It depends on the industry in which the company operates because some coefficients are critical in certain industries. In addition, it is discussed that the relationship of different ratios can also give a deeper understanding of the real situation of the company. It is also indicated that the formulas are only a basis and a recommendation, but managers can independently compose and calculate ratios that are important for their particular case.
References
Tay, K. (2019). Financial intelligence: The DNA of business and investments. Partridge Publishing.