Introduction
Investors are increasingly becoming aware of the need for comprehensive business analysis in their decisions regarding investment portfolios. With that, several analysis tools including financial ratios have gained prominence. However, although the ratios are some of the key indicators of a business’ performance, they are subject to some limitations. In that respect, this report seeks discuss some of those potential pitfalls and demonstrate the ratios’ application with analysis of Apple Company’s liquidity, efficiency and profitability.
Analysis
Potential Pitfalls in Ratio Analysis
Financial ratios have some limitations that require them to be used together with other financial analysis tools for a comprehensive analysis. Some of the limitations include:
Being subject to different accounting standards across the globe, hence making comparisons with other companies less reliable and in some cases not possible.
They may fail to reflect a company accounts’ true nature, as management may have attempted to conceal and gloss over some problems.
The ratios are calculated using past performance data, hence cannot be reliable in determining a company’s future (Byrd et al., 2013).
Apple Ratios Analysis
There are various types of financial ratios that measure performance in different aspects of a business. The ratios include those measuring liquidity, efficiency, and profitability, which have been calculated for the Apple Company as follows (Byrd, Hickman & McPherson, 2013).
Liquidity
Current ratio: The ratio is one of the key measures of a company’s liquidity and higher as well as rising values are a good indication of better and improving liquidity. It establishes a firm’s ability to meet its short-term obligations. (Byrd et al., 2013). The following table summarizes Apple’s current ratios for years 2014 and 2013.
Source: (Yahoo Finance, 2015b; 2015b).
The above ratios, which are more than one show that the company has had adequate current assets to cover the current liabilities, hence an indication of a suitable liquidity position. However, the decrease in the ratio in 2014 compared to 2013 shows reducing liquidity, hence a need to enhance short-term debt and current assets’ management.
Profitability
Profit margin: The ratio measure a company’s ability to generate profits given its revenues, hence a good measure of ability to manage expenses. Higher and rising margins are desirable as they indicate better performance (Byrd et al., 2013).
Source: (Yahoo Finance, 2015b; 2015b).
The profitability margins are high, hence an indication of good performance. However, the margin decreased in 2014 compared to the year 2013 showing decreasing ability to generate profits given Apple’s revenues. Thus, there is a need for better expenses management as a means of enhancing profitability.
Efficiency
Assets Turnover: The ratio measures a company’s ability to generate revenues given its asset level. Thus, it is a measure of effectiveness in managing the assets and higher as well as rising values are desirable as they show better and improving efficiency.
Source: (Yahoo Finance, 2015b; 2015b).
The Apple’s ratios are low, hence showing poor assets management. Also, the falling ratios in 2014 compared to 2013 show decreasing efficiency, hence a need to improve asset allocation and utilization for the purpose of better revenues generation (Byrd et al., 2013).
Conclusion
Given the discussion and analysis, financial ratios have some limitations including being subject to different accounting standards, the possibility of management’s gloss over issues and being dependent on past performance. On the other hand, Apple’s analysis has shown that, although the company has had suitable levels of profitability and liquidity, it has had poor efficiency in assets’ management. Also, its performance in all the three areas decreased in 2014 compared to 2013, hence a need for better efficiency, profitably and liquidity management.
References
Byrd, J., Hickman, K., & McPherson, M. (2013). Managerial Finance. San Diego, CA: Bridge point Education Inc.
Yahoo, Finance. (2015a). Apple Income Statement. Retrieved from, http://finance.yahoo.com/q/is?s=AAPL+Income+Statement&annual
Yahoo, Finance. (2015b). Apple Balance Sheet. Retrieved from, http://finance.yahoo.com/q/bs?s=AAPL+Balance+Sheet&annual
