If management is to maximize a firm’s value, it must take advantage of the firm’s strengths and correct its weaknesses.
(1) comparing the firm’s performance to that of other firms in the same industry and
(2) evaluating trends in the firm’s financial position over time.
When you finish this chapter, you should be able to:
• Explain what ratio analysis is.
• List the five groups of ratios and identify, calculate, and interpret the key ratios in each group.
• Discuss each ratio’s relationship to the balance sheet and income statement.
• Discuss why ROE is the key ratio under management’s control, how the other ratios impact ROE, and explain how to use the DuPont equation for improving ROE.
• Compare a firm’s ratios with those of other firms and analyze a given firm’s ratios over time.
• Discuss the tendency of ratios to fluctuate over time, explain how they can be influenced by accounting practices as well as other factors, and why they must be used with care.
