Ratios Are One Way to Help Assess Essay

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Ratios are one way to help assess the relative financial strength of an organization. Just as there are numerous ways that organizations can be organized, there are numerous different ratios that can be used to evaluate an organization's working capital and cash. Richard Loth breaks these various ratios into six different broad categories: liquidity measurement ratios, profitability indicator ratios, debt ratios, operating performance ratios, cash flow indicator ratios, and investment valuation ratios (2013). Liquidity ratios are focused on the company's ability to pay off short-term debt and compare a company's liquid assets to its short-term liabilities. Profitability indicator ratios help reveal how well the company is using its assets to generate profit. Debt ratios basically compare a company's debt to its equity or assets, which can help determine the financial strength of the company, indicate its creditworthiness, and warn of impending financial problems. Operating performance ratios focus on specific areas of operation in a company and give insight into the performance of that segment of the company.

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Cash flow indicator ratios examine how much cash is being generated and what type of safety net that cash provides to the company, taking into account that larger companies need access to larger safety nets. Finally, investment valuation ratios are focused towards investors and help indicate whether the company is a good investment option.

Organizations can benefit by monitoring financial indicators in a number of ways. First, they provide a good overview of an organization's relative performance. Second, they can help an organization become aware of potential problems; for example, a company that is seeking financing would need to know if its debt ratio would make it appear credit worthy. Third, they can help organizations adjust their business plans for growth; cash flow indicators can help a company determine the appropriate amount of cash reserves based on adjusted business size......

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