Usefulness of Accounting Ratios in Financial Analysis

Accounting ratios are a technique normally adopted by financial analysts in order to highlight the financial health of the company at hand.  There are a vast number of accounting ratios, each of which outlines certain aspect of the organisation.

The main areas normally considered are the financial performance, financial position and financial stability of the corporation.  In this respect it is imperative that one first classifies the ratios in accordance with the aforesaid categories.  In this respect, the ratios that portray the financial position of SR Building Service Limited are: current ratio, acid test ratio, stock turnover, debtors days and credit ratio.

Ratios are a static figure, which on its own merits is meaningless to the financial analyst.  Therefore it is important that such figure is either compared in the same organisation over time or with a company in the same or similar industry.  The financial ratios of Easy Build Limited are utilised in order to amplify the financial position of SR Building Service Limited.  This will provide fruitful information on such facet.

1.1 Financial Position of SR Building Service Limited

The financial position of the company will be examined in three main areas.  These encompass the working capital on a generic basis, followed by the management of stock and debtors plus creditors.  This will be conducted in the proceeding sections.

1.1.1 Working Capital of SR Building Service Limited

The capability of the current assets to cover the current liabilities of SR Building Service Limited is inferior to the other company.  This is revealed by the lower current ratio of the firm.  The variance of 0.71 indicates that the short-term liabilities of SR Building Service Limited are in a higher proportion to the current assets.  Such variable implies that management is less effective in administering the working capital of SR Building Service Limited.

Further more, the ability of the most liquid assets (debtors and cash and cash equivalents) to cover the short-term liabilities is also weaker than that of Easy Building Limited.  This factor is outlined in the lower acid test ratio amounting to 0.38.

It is therefore pertinent to state that on a generic perspective the financial position of SR Building Service Limited is worse than the other business entity.  Further amplification of the liquidity of the company can be performed by examining in more detail the main current assets and current liabilities of the organisation.  These encompass the analysis of the stock, trade debtors and trade creditors of the firm.  Such examination will be performed in the forthcoming sections.

1.1.2 Management of Stock

The stock turnover ratio portrays the number of times stock of the company is turned over.  The higher such ratio the more effective is the management in the utilisation of stock.  An organisation with a low stock turnover ratio normally implies that the company is stocking goods for a considerable time.

This is a highly risky element in light that the product may quickly turn obsolete realising a price lower than its original cost.  For example, stocking a lot for retailers of clothes and electronic equipment namely computer hardware is significantly risky.  Clothes may easily turn out of fashion leading to the aforementioned effect, and technological advancements may quickly turn electronic goods into obsolete products.  Indeed organisations like Toyota nowadays are adopting a Just in Time Inventory System.  Such technique encompasses keeping stock to a minimum, normally zero level.

In light of the above, SR Building Services Limited surpasses Easy Build Limited on the stock facet.  At this stage one would thus ponder the reason why the overall working capital of the firm at hand is weaker in comparison to Easy Build Limited.  The proceeding examination may shed further light on such matter.