10. Give a two-minute talk on the subject of monetary policy and interest rates. Unit 8

Pre-reading

1. Who may be interested in the financial information about the company?

2. What can be defined as ratio?

3. Can we determine the firm’s performance with the help of financial analysis?

1. Read and translate the text financial analysis

The financial manager should have a good understanding of the financial statements of the company in order to make an informed judgment on the financial position and operating performance of the entity. Financial decisions are typically based on the information generated from the accounting system.

Financial management, stockholders, potential investors and creditors are concerned with how well the company is doing. The reports generated by the accounting process and included in the company’s annual report are the balance sheet, income statement and statement of cash flow. The balance sheet reveals the company’s financial status as of a given date, while the income statement reports the earnings for the year. The statement of cash flow allows readers to analyze the company’s sources and uses of cash.

The information contained in the basic financial statements is of major significance to all users who need to have relative measures of the company’s operating efficiency and condition. Relative is the key word here since the analysis of financial statements is based on the knowledge and use of ratios or relative values.

Ratio analysis involves the methods of calculating and interpreting financial ratios in order to assess the firm’s performance and status. The basic inputs to ratio analysis are the firm’s income statement and balance sheet for the period to be examined.

Ratio is the relation between two amounts determined by the number of times one contain the other, e.g., ‘20/4=5’, or ‘The ratio of 20 to 4 is 5’. The ratios of 1 to 5 and 20 to 100 are the same.

So, the most often used measure is a ratio, or, index, relating two pieces of financial data to each other.

Ratio analysis does not merely involve the application of a formula to financial data in order to calculate a given ratio. More important is the interpretation of the ratio value. To answer such questions as, “Is it too high or too low?” “Is it good or bad?”, a meaningful standard or basis for comparison is needed. Two types of ratio comparison can be made: industry comparison and trend (time-series) analysis.

Industry comparison involves the comparison of different firms’ financial ratios at the same point time. The typical business is interested in how well it has performed in relation to its competitors. Often the firm’s performance will be compared to that of the industry leader, and the firm may uncover major operating differences, which, if changed, will increase efficiency. Another popular type of comparison is to industry averages. These figures can be found in the Almanac of Business and Industrial Financial Ratios, FTC Quarterly Reports, and other sources.

Time-series analysis is applied when a financial analyst evaluates performance over time. Comparison of current to past performance utilizing ratio analysis allows the firm to determine whether it is progressing as planned. When financial ratios are arranged on a spreadsheet over a period of two or more years, the analyst can study the composition of change and determine whether there has been an improvement or deterioration in the financial condition and performance of the firm. Developing trends can be seen by using multiyear comparisons, and knowledge of these trends should assist the firm in planning future operations. As in cross-sectional analysis, any significant year-to-year changes can be evaluated to assess whether they are symptomatic of a major problem.

Before describing specific ratios, it should be stressed that a single ratio does not generally provide sufficient information from which to judge the overall performance of the firm. Only when a group of ratios is used can be reasonable judgments be made. Finally, it should be noted that accounting data from different companies should be standardized as much as possible. It is important to compare apples with apples and oranges with oranges.

There are four basic types of ratios associated with financial statements:

1. Liquidity ratios indicate the ability to meet short-term obligations as they are due.

2. Activity or utilization ratios indicate the extent to which assets are turned over, or used to support sales.

3. Financial leverage ratios indicate the extent to which borrowed or debts funds are used to finance assets.

4. Profitability ratios indicate the firm’s effectiveness in terms of profit margins and rates of return on investment.