Ratio Analysis with Financial Statements

Understanding ratio analysis is foundational to making sense of financial and operations ratios. An organization s successes and areas in need of attention from management are highlighted by performance ratio analysis. Ratios are used to evaluate the performance of an organization, an industry, and management personnel. 

Financial statements were explained in detail in Chapter 3, providing a foundation to understand ratio analysis. This chapter will introduce many of the common financial performance ratios that executives and analysts use. In addition, the chapter will explain how to compute ratios, what information the ratios offer for decision making, and how to consider multiple factors that are critical to fully understanding the ratios. In subsequent chapters, how operations and supply chain ratios affect and influence financial ratios will be examined. Operations ratios, after all, are used to ensure that financial performance meets the e q)ectations of creditors, investors, and executives. Ultimately, these ratios provide information about an organization s financial health and ability to continue operations. 

Before financial ratios are discussed in detail, a general introduction to ratio analysis is provided first. How might ratio be defined anyway A ratio is a relationship or comparison between two numbers. It is a statement of how two numbers compare to each other. It compares the size of one number with the size of another number. It is the quantitative relation between two amounts showing the number of times one value is contained within the other. 

Once it is understood that ratios tell a story about how a company is performing, decisions must be made regarding the number of and which performance ratios to use. Considering too many measures can burden an organization as it collects and analyzes a vast amount of data excessive data can lead to decision paralysis. Focusing on too few ratios, though, will not provide a comprehensive picture of 

Consider the following scenario. As the manager of inventory for your company, you are told to improve inventory effectiveness by your managing director. Because you are familiar with inventory ratios and performance measures, you do not ask any additional questions. You have identified and selected the following inventory ratios and perfor- 

---

Chapter 4 Ratio Analysis with Financial Statements... 

The chapter considered the engineer s fear of financials and attempted to overcome it with a straightforward discussion of cash flow, income, and balance statements. The mathematics of these statements is simple arithmetic, but the confusion seems to come from not understanding a few key terms. The chapter also considered the utility of ratio analysis—what engineers might call dimensional analysis for companies—breakeven analysis, and the basics of the time value of money. Although a full discussion was beyond the scope of this chapter, the discussion served up the basics and may also serve to introduce more careful treatments in other courses or texts. 

---