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My Financial Ratios Discussion:

Referencing this week’s readings and  lecture, what are the limitations of financial ratios? Classify your  answer into at least the following categories: liquidity ratios,  activity ratios, leverage ratios, and profitability ratios.

Respond to at least two of your classmates’ posts.

Quentins Discussion Reply and include sources provided:

 

According  to our weekly lecture, Cain defined the following four ratios, namely  liquidity ratios, which “help determine whether a company is liquid  enough to cover up its current liabilities.” Activity ratios “establish  how a company makes use of its resources through comparison of certain  activities.” Leverage ratios “establish the level of debt owed to  creditors by a company and whether such a company is in a position to  pay its long-term liabilities.” Lastly, profitability ratios “establish  whether it is operating at a profitable level and measure the success of  the company in the industry” (Cain, 2018, Week 6 Lecture).

The limitations of these financial ratios vary depending on the type  of ratio presented. For the liquidity ratio, limitations may rise due to  the fluctuation of sales at certain times of the year. Activity ratios  may experience a type of constraint due to the late customer payments  and also seasonal sales being higher than others. Leverage ratios  experience issues when debt is too high being that the debt still has to  be paid at some point. For profitability ratios also depend on whether  or not companies can pay their debts and how much profit is being  generated. Other limitations include inaccurate data on statements,  times of inflation, and fixed assets at cost (Epstein, 2014).

Cain, M. (2018). Week 6 Lecture. Retrieved from  https://ashford.instructure.com/courses/21789/pages/week-6-weekly-lecture?module_item_id=1104041

Epstein, L. (2014). Financial decision making: An introduction to  financial reports [Electronic version]. Retrieved from  https://content.ashford.edu/

Edwards Discussion reply and use sources in reply:

 

While  financial ratios can be used to access a company’s performance in  regards to their financial health, they have multiple limitations that  can prevent an analyst from getting a full examination. Liquidity ratios  for instance may be used by a financial institution when they are  determining whether the borrower has enough cash flow to pay of current  debt. However, using a liquidity ratio would get inaccurate results if  the company measured their performance multiple times a year because the  numbers could fluctuate. Activity ratios can be used by an analyst to  see how much of a company’s assets can be converted into cash. However,  “assets are valued at cost and may not reflect the current market value  of assets which can distort ratios that use asset values, especially  when comparing a company with primarily older assets to a company just  starting up” (Epstein, 2014, p. 6.2).

Profitability and leverage ratios are used to determine how  money a company makes and how much capital they have but they are  inefficient if a financial analyst is looking for future projections.  Not to mention that all the financial ratios mentioned will have  inadequate results if the company only has high level performances  during peak seasons. A company that sells lawn equipment will have peak  sales during the warms but will have low sales when it gets cold.  Conclusively, all financial ratios would be difficult to use if a  company sells items in different industries because it would be too hard  to analyze what other corporations to deploy for products sold  comparison.

References

Dobosz, J. (2013). Ten ratios to make you money in stocks. Forbes. Retrieved from http://www.forbes.com/sites/johndobosz/2013/09/25/10-ratios-to-make-you-money-in-stocks/ (Links to an external site.)Links to an external site.