Ratio Analysis

Balance Sheet and Income Statement are important, but they are only the starting point for successful financial management.  Ratio Analysis could be applied to Financial Statements to analyze the success, failure, and progress of business (Foster, 1978).

Ratio Analysis allows the business owner/manager to mark developments in a business and to compare its performance and condition with the average performance of similar businesses in the same industry or comparing current year’s performances with the previous year’s performance (Horrigan, 1968).

 One of the ways to compare performance of a business is by ratio analysis. Comparing current years financial statements with the previous year’s financial statements may help investors and other interested parties to understand the stability and performance of the business (Foster, 1978). Ratio analysis may provide the all-important early warning indications that allow solving business problems before the business is destroyed.

This paper provides a critical review of the theoretical and practical basis of four central areas of financial ratio analysis. The research areas reviewed are the Profitability ratios, Liquidity Ratios, Capital Structure Ratios and Investment Ratios.  It is observed that it is typical of financial ratio analysis research that there are several unexpectedly different looks with research traditions of their own. A common characteristic of all the areas of financial ratio analysis research seems to be that while significant regularities can be observed, they are not necessarily stable across the different ratios, industries, and time periods. This leaves much space for the development of a stronger theoretical basis and for further practical research (T. S. and T. Martikainen (1994).

This research study is based on secondary data, means data that are already available i.e. the data which have been already collected and analyzed by some one else.

Secondary data are used for the study of Ratio analysis of this company. To collect the data I have refered – Company annual report, annual magazine, last 5 year balance sheet, and cash flow statements.

Another source of secondary data was in the form of reference books and Literature Review published by third parties but available to the public. The World Wide Web (Internet) was also an important source of information related to ratio analysis.

This research was based on analyzing the financial statement of one of the biggest manufacturing companies in Cyprus – CYPRUS TRADING CORPORATION LTD by ratio analysis, concentrating on the questions of how the company performed in the year 2010 compared with the previous year (2009) and how this information will be useful to third parties on their decision making. The importance of this research is that the financial ratios are widely used for modeling purposes both by practitioners and researchers. The firm involves many interested parties, like the owners, management, personnel, customers, suppliers, competitors, regulatory agencies, and academics, each having their views in applying financial statement analysis in their evaluations. Ratio analysis of the financial statements of CTC for the years 2009-2010 showed the overall performance of the company compared with the previous year and as a result based on all the calculations and analysis of all available ratios a conclusion has been made that the company has developed and improved its performance in 2010 compared to 2009.

Ratios are divided into four main groups:

1. Profitability Ratios – These are ratios used to asses a firms profitability.  It is the aim of all firms to make a profit because profit provides the income for the owner(s); it enables firms to put away reserves in case of future needs (Chen and Shimerda (1981).  Profit is also a source of funding for investments as well as an indicator of the health of the firm.  It is very important that a firm’s financiers, shareholders and potential investors have a reliable measure of the ability of the firm to generate satisfactory profits and be able to compare these with profits made by the same firm in previous years (Luoma and Ruuhela (1991).

2. Liquidity Ratios –, These are ratios that show the ability of a firm to meet commitments as they fall due.  A firm should have sufficient liquid resources (cash and assets readily convertible into cash) to meet all current liabilities. 

 “Liquidity is the ability of the firms to meet its current obligations as they fall due” (Saloman J. Flink).

3. Capital Structure Ratios – These ratios can also be called financial leverage ratios. They are used to see whether companies finance their activities mainly by attracting investments on their equity shares or borrowing from banks.  Measures of financial leverage are tools in determining the probability that the firm will default on its debt contracts (Vatter (1966).

4. Investment Ratios – Also called Market Value Ratios are of great interest to investors.  Balance sheets and Income statements give us a lot of information about the business but they do not give us any information about important characteristics such as the market value.  Therefore investment ratios are used to overcome this situation.  These ratios are applicable to public limited companies (Stauffer (1971).