Financial ratios are an important indicator regarding the financial health of a firm. They can indicate the profitability, liquidity as well as solvency for a company. This is the reason why it finds different kind of audience and in a large scale.
The major groups which use financial ratios are the company management, the Board of Directors, the shareholders, market participants at large, rating and research agencies, and also to by regulators and auditors (Macs Accounting Dictionary).
The management of a firm are concerned about specific ratios which explain the operating and financial performance of a firm for a particular period, while briefly comparing the ratios with those of previous periods.
The Board of Directors want to ensure that the reputation and sustainability of the firm are maintained and use some specific ratios to measure this. They generally use customized reports according to their requirements and in an adhoc manner.
The shareholders look for periodic performance increase in the operations of the company through various ratios reported by the firm. Their primary goal is dividends and/ or capital gains, which come through better financial performance by the company.
The market participants such as big corporate, high net worth individuals etc. look for sustainability of performance of a company through these ratios so that they can identify long term investment targets which can give them very high returns.
Rating and research agencies come out with recommendation and update reports after the results of a company are declared. These agencies use various ratios to arrive at their recommendations and ratings.
Regulators and auditors too use financial ratios to ensure that the firm is reporting its accounts accurately and confirming to all the accounting standards and practices. It also gives them an idea about the sustainability of the firm’s performance.
The balance sheet is generally prepared on a specific date. This date can be at any time of the year. This statement shows the value of the assets, liabilities and the equity of the firm on that particular date (Way).
Balance sheet items are the ones where their value gets added to the previous period value. Thus the position on a specific date can be compared to the position on a previous date, with the difference showing the addition or subtraction in that account in between the two dates.
On the other hand, income statement is prepared for a particular period and reflects the position of the items during the period. This statement too can be prepared for any particular period (Way).
The income statement items show the performance in between the two particular dates and the value does not get added to the previous period figures, as is the case for balance sheet items.
The major balance sheet categories are assets, liabilities and equity. The assets of a company are always equal to the liabilities plus equity. This is true for any date for any company. There are further major accounts within each of these categories.
Assets are majorly either current assets or fixed assets, while liabilities are either short term or long term. Equity comprises of paid up capital, share premium and reserves and surplus. As can be seen, these items are all that get added to the previous period figures.
Major income statement heads are total revenues, cost of goods sold, gross profit, depreciation and amortization expenses, interest expenses, tax expenses and net profit. These figures reflect the performance during a particular period and do not get added to the previous period figures.
The primary functions of a financial manager relate to forecasting and planning the funds required for the operations of the company, to make decision on various investments, to make financing decisions, to make dividend decisions, evaluation of financial performance and to interact with various financial market participants (College Accounting Coach, 2008).
All these roles and functions boil down to the fact that the financial manager wants to make the company have a good financial and operating performance, which adds to shareholder wealth and is sustainable, which is his primary objective.
The forecasting and planning functions relate to estimating the business growth for the firm and the amount of funds that would be required to have that kind of growth. This also entails estimating the internal funds generation by the company and how that can be used for business opportunities.
Investment decisions refer to taking decision on new projects and opportunities which are profitable and would add to the shareholder wealth. These projects can be accepted or rejected on the basis of various parameters and tests, which the financial manager undertakes.
Financing decisions refer to deciding the right capital structure of the company so that the required amount of equity and debt can be raised from the market. This is one of the most important functions of a financial manager as this determines the cost of capital for the firm, which affects almost all operating decisions.
The internal generation that takes place at the end of the period then has to be either given out as dividends or reinvested in the company. The financial manager does this by keeping in mind the primary objective of maximization of shareholder value.
References
Macs Accounting Dictionary. Financial Ratio Analysis Users. Macs Accounting Dictionary. Retrieved from http://www.macsfinance.com/macs_dictionary/financial-ratio-analysis-users.
Way, J. The Differences in Dates Between a Balance Sheet and an Income Sheet. Small Business Chron. Retrieved from http://smallbusiness.chron.com/differences-dates-between-balance-sheet-income-sheet-24881.html.
