Summary Of Jimco's Financial Ratios
Table 5-7 summarizes Jimco's financial ratios, as well as the corresponding industry norms. Briefly, the results of those comparisons are as follows:
- Jimco's liquidity position in much better than the industry.
- Jimco has made extensive use of financial leverage.
- The firm cannot afford any further use of financial leverage, as is indicated by the times interest earned ratio.
- The firm must re-examine its policies for accounts receivable and inventory management, as indicated by both the average collection period and the inventory turnover ratios.
- Jimco's profit margins are better than the respective industry norms; however, the firm has not been able to convert these profit margin into better than average rates of return on investment.
- Finally, Jimco has benefited from the favourable use of financial leverage.
An Integrated Form Of Financial Analysis Based On Earning PowerThe analysis of a firms's earning power involves a two-stage procedure designed to answer two basic questions:
- Stage 1
- How effective has the firm's management been in generating sales using the total assets of the firm and converting those sales into operating profits?
- Stages 2
- How effective has the firm's management been in forming a financial structure that increase the returns to the common shareholders? Here we analyze the effect of the firm's financing decisions (that is, the mixture of bet and owner financing used by the firm) on the rate of return earned on the common shareholder's investment.
The operating income return on investment can be broken down into the product of two ratios,
|Return on Investment =||Operating Income||x||Operating Income|
|Operating Income =||Sales|
Figure 5-4 simply lays the relationships that underlie the operating profit margin and total asset turnover ratios. Figure 5-5 provides a template for use in analyzing the effect of the firm's financing decisions on the return earned on the common shareholder's investment. The analysis presented in Figure 5-5 depends on the following basic relationship:
|Return on Common Equity =||Net Income Available to Common Shareholders|
The 10-step procedure outline in Figure 5-4 and 5-5 connects the return earned on common equity to the firm's use of financial leverage and the operating profitability. The real value of this approach to financial analysis is its ability to demonstrate the interrelationships between the return earned on the owner's investment in the firm and a wide variety of financial attributes of the firm.