Final Paper

Essay by HYPERSDTUniversity, Bachelor's January 2008

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A financial ratio is a ratio of selected values on a company's financial statements. There are a few common ratios used to measure the overall financial condition of an organization. Financial ratios are used by managers, stockholders and creditors. Security analysts use these various ratios in order to compare the strengths and weaknesses within the selected companies. Decimal values and percentages are used to express the ratios. Financial ratios allow for comparisons between companies, industries, different time periods, and a company's industry average. "Profitability ratios measure a company's use of its assets and control of its expenses to generate an acceptable rate of return" (Profitability Ratio, 2007). Basically, profitability ratios are a comparison of two or more financial variables that help evaluate a company's income earning performance.

Accountants and stock analysts have found a great and secure way to measure management efficiency. They have decided that a return on equity (ROE) and return on assets (ROA) are both efficient and effective ways of measuring the management efficiency ratios.

Both of these ratios measure how much earnings a company is making from its resources. "Return on equity is calculated by taking income (before any nonrecurring items) and dividing it by the company's common equity or book value. Expressed as a percentage, it tells you what return the company is making on the equity capital it has deployed. Return on assets is income divided by total assets. It gives you a sense of how much the company makes from all the assets it has on the books - from its factories to its inventories" (Fundamental Data: Efficiency Ratios, 2007). Ratios that measure pure efficiency of a company are rarely accurate. It has been proven that earnings can be manipulated and that asset values on balance sheets do not really prove what a...