Use of Financial Ratios Essay Example | Topics and Well Written Essays - 1000 words

Use of Financial Ratios - Essay Example The paper is an attempt to analyze the accuracy of the statement of Lev and Sunder using some evidences taken from real world, especially by doing the cross sectional analysis of financial ratios. Use of Financial Ratios Financial ratios are used to measure a company’s financial condition or to analyze between two companies’ financial condition. All the stakeholders of the company have interest in company’s future, that is how the company would perform in the short term or long term future, how much it is secure to invest in the company, what type of change should be introduce so that the company can perform better. When an investor wants to take the decision to invest money, certainly he wants to invest it in the most effective company, the decision he can take by using the financial ratio analysis along with other type of analysis like qualitative analysis or other type of quantitative analysis. Critical Analysis Ratio analysis is a very widely used tool for analyze the financial stability of a firm. But there are certain problems arise when the analyst don’t take the associated factors in consideration. When the analyst is doing the performance analysis of two companies, they should remind that two companies can follow two different accounting policies. There is no single accounting standard which is being followed by the companies all over the world. (Fischer, Taylor and Cheng, 2008, p.505). The taxation rules of different states, different countries vary over the world. The inflation over the world is different. A multinational company has to face different taxation policy, different inflation over the world. So when a researcher is analyzing the performance of a company using ratio analysis, he should take these factors in account. There are also technical factors associated with the analysis. Many statistical tools which are being used in ratio analysis are based on the assumption that the data are normally distributed, but in reality that doesn’t happened. For identifying the financial indicators specifically for Critically Access Hospitals the Flex Monitoring Team used 114 financial ratios as their part of research. But they found many problems when research about the industry, like Hospitals with negative current Assets or negative current liabilities was excluded from the calculation of median, but that should be i ncluded when researching about the liquidity of the industry (Flex Monitoring Team, 2005, p.17-18). A research study was performed by taking 66 listed Malaysian firms’ data for the period 1980 to 1996. The forms were taken from 3 sectors industrial sector, mixed industry and combination of industrial and property sector. From the research it has been seen that only current asset percent was conformed to normal distribution. For doing the ratio analysis effectively three type of transformation techniques were used namely square, square root and natural log. When the square and square root property were used they were found as not effective, because the variables of the ratio analysis are not normally distributed. But natural log technique is proved effective by the researcher as the process considers that the data available is not normal. The researcher proved through the research that when a ratio analysis is being performed to analyze the performance of a company or comparab le analysis between two companies is done then they should address the proportionality effect on the ratio’s normality (Sori et al., 2006, p.71-81). From a survey done on U.S.A. firms it is clear a ratio can