Method of ratios for financial analysis
The financial analysis also uses the method of ratios. Ratio is a Saxon word derived from the Latin word ratio, reason and relationship. The ratio allows to know the solvency ratio, which indicates whether a company is solvent or not. The most important ratios used for financial analysis are:
1. Liquidity ratio, also called short-term solvency. Represents the relationship between the company’s assets and liabilities.
2. Acid ratio (acid test), represents a financial position in the very short term.
3. Defensive position, a ratio that indicates the time (in days) that the company would have to survive solely by applying the assets that the company has in the time when this ratio is calculated without taking into account funds from present or future sales.
4. Capital adequacy ratio or distance out of business, reflect the totality of the real assets owned by the company to meet the total debt you have.
5. EPS (Earning per share), shows the benefit for each action.
6. Policy Pay dividends or out, measures the percentage of profit that is distributed to shareholders.
7. PER (Price Earning Ratio) represents the number of times the benefit of an action is contained within your price.
When the analysis reflects economic and technical insolvency insolvency. If there are two enemies which by nature must be avoided at all costs a company are economic hardship and technical insolvency. The economic insolvency (bankruptcy) occurs when the liabilities of the company is greater than the assets. The technical insolvency (bankruptcy) occurs when even though the assets exceeds the liabilities, the company lacks sufficient resources to cope with the payment of its obligations, and that there is no correspondence between the cash flows of entry and monetary flows out. In both cases the first symptom of insolvency is beginning to be the layoffs of employees of the company.
Importance of financial analysis in business
The financial analysis is one of its main functions to anticipate and prevent conditions of insolvency, which otherwise, in addition to damaging the image of the company would bankrupt, which undoubtedly marked the beginning of the end of the company or talking in terms of employment contracts would be to sign the settlement of the same and to feed even with small doses on a company’s current economic crisis.