X. Task 1. Read the text and say what the best way to make the meaning of a company’s ratios clear is

Once you understand how a set of accounts is constructed, you need to be able to analyse them to find out what they really disclose. Interpreting and analysing financial statements will enable you, as a manager, to compare the performance of your company this year with last year, to compare your company with its competitors, and to detect weaknesses which you can improve.

Absolute figures in financial statements do not tell you much. For example, to be told that Retail Stores Plc made £196 million profits before tax is not a useful piece of information unless it is related to, say, the turnover which produced the profit or to the capital employed in the group.

Ratio analysis is a useful tool with which to interpret financial accounts. But for ratios to be meaningful, they must be compared with equivalent ratios calculated for previous years and with those of the industry in which the company is positioned. Industrial ratios are produced by a variety of clearing houses for industrial statistics.

Ratios reduce the amount of data contained in financial statements to workable form. This aim is defeated if too many are calculated. You must learn which combination of ratios will be appropriate to your needs.

Ratios lead you to ask the right questions; however they seldom provide conclusive answers.

A financial ratio is a number that shows the relationship between two elements of a firms financial statements. Many of these ratios can be formed, but only about a dozen or so have real meaning. The information required to form these ratios is found in the balance sheet and the profit and loss accounts.

Liquidity

Your first concern as a manager is to ensure the short-run survival of the company. Is the company able to meet its short-term obligations?

Most commentators prefer to see a company with more current assets than current liabilities. But in the retail sector, most companies work on cash sales (i.e. no debtors) which makes for healthy liquidity.

In some manufacturing companies stocks are too high and contain obsolete, unsellable items. To provide a more rigorous test of the company’s ability to meet its short-term obligations, this item is removed from the calculation.