The company Piggle plc had a return on capital employed of 20% with the return on equity of 10% which is determined by the ratio of net income to the total equity of the company. The net profit margin of the company that is, the profit after interest but before payment of tax is said to be 9%. For the company, the average settlement period of debtors and the average settlement period of creditors are 25 days and 45 days respectively. The stock holding period of the company is 21 days with a gross profit margin of 27%.
The company had 3 times of fixed asset turnover and a capital gearing ratio of 15%. The current ratio of the company is 9:1 and the acid test ratio is 1:1. This company had a price earning (PE) ratio of 10.For the evaluation of business performance of two firms, the most helpful and significant method is the ratio analysis. The different ratios used in ratio analysis helps in determining the relative performance of two companies and their valuations. The ratio analysis provides the overall profile along with the economic characteristics and the competitive strategies of the company.
The major advantage that ratio analysis provides is the comparison of firms of different sizes. In ratio analysis, process of standardization is very important and is needed in the construction of different ratios, for this some specific differences among the firms are ignored. Ratio analysis is one way which helps in putting the financial statements to work. Ratios are nothing but a number divided with another to show the relationship between them. In finance, two items of financial statement are divided with each other which provide practical and sufficient information for the user for analyzing the business performances of firms.
Not all the ratios that can be obtained from financial statements are of equal importance; some of them are not so helpful and can be ignored. The ratios are classified into four areas, liquidity, turnover, profitability and debt. (Atrill and McLaney, 2006)
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