Pearson Etext For Foundations Of Finance -- Combo Access Card (10th Edition)
Pearson Etext For Foundations Of Finance -- Combo Access Card (10th Edition)
10th Edition
ISBN: 9780135639344
Author: Arthur J. Keown, John D Martin, J. William Petty
Publisher: PEARSON
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Chapter 4, Problem 1RQ

Describe the “five-question approach” to using financial ratios.

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Summary Introduction

To discuss: “Five question approach” using financial ratios.

Explanation of Solution

  • How liquid is the firm? : This is to determine whether the company is able to repay creditors in a timely manner and compare current assets with current liabilities as well as the nature of the current assets.
  • How is the firm financing its assets? : To answer this question, the debt ratio is determined and the time interest earned is also measured.
  • Are managers providing good returns on capital to shareholders? : To determine this, return on equity analysis is calculated and compared to competitors.
  • Are managers generating adequate operating profits from its assets? : The company’s profitability, operating income and turnover ratios of the company are measured to determine the location of the assets.
  • Are managers creating shareholder’s value: The value is generated by the managers is determined by the added economic value or the market value ratios (price/earnings and price/book ratios) are analysed.

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