Financial Ratios Calculation & Interpretation Application Essay

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This ratio eliminates the stock figure from that of current assets and like the current ratio; it is used to measure the liquidity of a firm. The quick ratio may in some instances be preferred over the current ratio as it is inherently difficult to turn some assets into cash. In regard to the two companies, the quick ratio brings out Plume Inc. As being more risky as it is more likely to default on its short-term obligations. According to Tracy (2009), the quick ratio of a firm should ideally be grater than 1.

Part B: Health and Risk Analysis in Brief

Looking at the debt to asset ratio, Arrow Company comes across as being more risky than Plume Inc. This is basically because its higher debt to assets ratio exposes it to a larger amount of debt which both investors and creditors may be wary of. Further, the higher debt to equity ratio in the case of Arrow Company could put the company in risky position if the level of debt used becomes too high. Using these two financial leverage ratios, one can conclude that the solvency of Arrow Company is not guaranteed in the long-term. The lower current ratio in the case of Arrow Company also means that it is more risky than Plume Inc. In the eyes of creditors.

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However, looking at the quick ratio, Plume Inc. whose quick ratio is less than 1 comes across as being less appealing particularly to creditors than Arrow Company. When it comes to the profitability ratios, Plume Inc. seems much more successful in profit generation than Arrow Company. Thus using the gross margin ratio as well as ROA and ROE as presented in the text above, one could argue that Plume Inc. is more profitable than Arrow Company. Based on the profitability and risk analysis in this section, Plume Inc. seems to be less risky and in better financial health than Arrow Company.

Part C: Overall Reaction to the Exercise

The relevance of financial ratios cannot be overstated especially when it comes to charting the anticipated performance of a given firm going forward. With that in mind, this exercise enabled me to gain hands-on skills on working with ratios. The real life examples involving the two companies give the exercise a more practical feel. However, for learning purposes, it would also be better to compare several financial statements (for different years) of each company so as to ease the analysis of the company's performance over time......

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