Introduction
Financial statement analysis reviews and analyzes a company’s financial statements to make better economic decisions. These statements include the balance sheet, income statement, statement of cash flows, and statement of changes in equity. Financial statement analysis is a method used by stakeholders, including investors, creditors, and management, to evaluate key factors such as a company’s profitability, liquidity, and solvency, and to understand its performance over time.
Current Ratio
Calculation
This paper will focus on the current ratio, one of the many financial ratios used in financial statement analysis. The current ratio is a liquidity ratio that measures a company’s ability to pay off its short-term liabilities with its short-term assets (Pink & Song, 2020). It is calculated as follows: Current Ratio = Current Assets / Current Liabilities.
Meaning
The higher the ratio, the better a company can cover its short-term liabilities. If the ratio reaches 1, the company has enough to cover its short-term debts. If it is higher than 1, that is generally a good sign—the company can comfortably cover its debts (Pink & Song, 2020). However, if it is significantly higher, a company may need to question whether it is making the best use of its cash and other readily sellable assets.
Use
Financial managers use the current ratio to understand the company’s short-term financial health. A lower-than-acceptable current ratio can be a warning sign of potential financial distress, prompting the company to take corrective measures (Pink & Song, 2020). On the other hand, a higher-than-normal current ratio may indicate that the company is holding onto too much cash or not investing its current assets effectively, which can also be a cause for concern.
Conclusion
In conclusion, financial statement analysis and ratios, such as the current ratio, are critical tools in a financial manager’s toolkit. They help provide a clear picture of the company’s financial health profile and current situation, enabling managers to make informed decisions that steer the company toward its financial objectives.
Reference
Pink, G. H., & Song, P. H. (2020). Gapenski’s understanding of Healthcare Financial Management. Aupha/Hap Book.