Question

A company reports accounting data in its financial statements. This data is used for financial analyses that provide insights into a company’s strengths, weaknesses, performance in specific areas, and trends in performance. These analyses are often used to compare a company’s performance to that of its competitors or to its past or expected future performance. Such insight helps managers and analysts improve their decision making.

Consider the following scenario:

Your boss asked you to analyze Green Hamster Manufacturing’s performance for the past three years and prepare a report that includes a benchmarking of the company’s performance. Using the company’s last three years of financial reports, you’ve calculated its financial ratios, including the ratios of Green Hamster Manufacturing’s competitors—that is, comparable ratios of other participants in the industry—and submitted the report.

Along with calculating the ratios, what else is needed for your report?

Making observations and identifying trends that are suggested by the ratio analysis

Identifying the factors that drive the trends in the ratios

Both of the above

Answer 1

Both of the above

Answer 2

Ratios are calculated using a company’s balance sheet, income statement, and other financial statements. It is important to realize there is a difference between computation and analysis. Ratios themselves do not provide the answer to a company’s performance, but they do serve as indicators of certain aspects of a company’s performance. Besides providing the calculations, you will have to interpret the information that ratios provide, analyze trends in the company’s performance, and draw conclusions about the factors driving those trends.

You’ve also been asked to compare the data with those of other players in the industry. The process of comparing a company with a set of other companies is called benchmarking. You calculated the ratios of Green Hamster Manufacturing’s competitors, but just computing the financial ratios does not serve the purpose of the report. Based on the suggested strengths and weaknesses indicated by the ratios, you will have to make inferences and observations regarding Green Hamster Manufacturing’s performance as compared to its competitors.