Comparison of ratios over a two-year period Research Paper

Comparison of ratios over a two-year period - Research Paper Example Besides, financial ratio analysis can also be used to assess the performance of different departments and managers and how their overall performance may have an impact on the performance of the whole firm. Sparklin Automotive Company is in business since 1990 and is supplying different automotive related parts across the whole country. In order to better assess its performance for the year 2005 and 2006, a comprehensive ratio analysis is important. This will provide a critical insight into areas such as liquidity management, overall asset management, the nature and extent of firm’s debt as well as assessing the profitability during these two years. Ratio Analysis Explanation Ratio analysis is the process of calculation and comparing the ratios which have been extracted from the different financial statements. By forming the historical trends, ratio analysis can actually provide an insight into the performance as well as charm in the company to perform in the long run based on the historical data. Ratio analysis is also important from the perspective of assessing the performance of the managers and understanding as to how the organization is performing. By computing financial ratios, a firm not only compares its performance with the competitors but also get an insight into its own historical performance. Ratio analysis therefore can be used for two different purposes or in two different manners i.e. making comparisons through trend analysis and comparing the ratios with the competitors. When financial ratio analysis is used for the purpose of trend analysis, a firm or a manager can actually get an insight into how the trends in different ratios are pointing towards the performance of the firm. For example, if a manager wants to assess as to how the overall inventory has been managed through out the year, she can compute the inventory turnover ratio and days in inventory to get an insight into how the inventory of the firm has been maintained and how sales have been generated. Ratio analysis therefore provides an ability to perform objective analysis of the performance of the firm. (Bull, 2007) Ratio analysis can either be used by the firm for its own evaluation purposes so that managers can assess what is required to be done in order to improve different areas lacking in achieving the targets. Secondly, ratio analysis can also be used by the investors to not only assess the historical performance of the firm but based on this assessment make forecasts as to how the firm may perform in future. Ratio Calculation Ratio Formula 2005 2006 Current Ratio Current Assets /Current Liabilities 1.475:1 1.403:1 Debt to Equity Ratio Total Liabilities / Total Equity 0.449:0.551 0.440 : 0.56 Inventory Turnover Sales / Inventory 6.11 times 4.620 Times Receivables Turnover Sales / Receivables 18.24 times 18.16 times Gross Margin Gross Profit / Sales 49.19% 40.70% Evaluation of the Ratios Current Ratio Current ratio is one of the basic indicators for assessing the liquidity position of the firm and indicates as to whether the firm has the required liquid assets to pay off its immediate liabilities. A current ratio of higher than 1 is considered as acceptable because for ever $1 of current liabilities firm has more than $1 of current assets to settle these