Potential Issues in Ratio Analysis

Weaknesses of ratio analysis

Ratio analysis is an essential technique used for carrying out financial analysis. The technique has several drawbacks. First, the operations of several companies cut across several industries. For such companies, it may not be possible to come up with ratios for these numerous divisions. Such companies come up with a single ratio for the entire organization. This may not represent all the divisions. Therefore, ratio analysis is appropriate for firms operating in a single industry. Secondly, inflation distorts the values reported in the financial statements, especially the balance sheet. Therefore, the book values are often different from the market values. Market values would be more appropriate than book values. However, it is not possible to get market value figures for items such as used assets because they are not traded. This makes ratio analysis less appropriate. Further, seasonal factors can also affect ratio analysis. This requires a person to have a prior knowledge of the seasonal factors when using ratio analysis. Also, use of unlike accounting practices hinders comparison of ratios across companies. For instance, the use of different depreciation method may hinder comparison (Atrill, 2009). Another drawback of ratio analysis is that, it is hard to come up with a broad decision on whether a ratio is satisfactory or unfavorable. For instance, a high current ratio may be favorable as it indicates a strong liquidity position. It may also be unfavorable because it shows that a company has excessive cash. Finally, a company may have favorable ratios in one category and unfavorable ratios in another category. This makes it difficult to draw a conclusion on the overall performance of the company.

Ratio analysis for Superior Energy Services

Liquidity ratios

Current Ratio 2.31 times
Quick Ratio 1.78 times

The ratios show that the current assets and liquid assets exceeded the current liabilities. The liquidity ratios are high and they show that the company has a satisfactory financial strength.

Profitability

Profitability
Net Margin -2.42%
Return on Assets -1.46%
Return on Equity -2.66%
Return on Invested Capital -0.71%

The gross profit margin was high (32%). The net profit margin was (2.42%). Return on assets was (1.46%), return on equity was (2.66%) while return on invested capital was (0.71%). The four ratios were negative. The gross profit margin shows that the company performed well while the other four ratios in the same category show that the company performed dismally. This inconsistency is a major weakness of ratio analysis.

Efficiency

Days Sales Outstanding 77.74 days
Days Inventory 24.84 days
Payables Period 29.46 days
Fixed Assets Turnover 1.47 times
Asset Turnover 0.61 times

The asset management ratios give information on the level of efficiency of the company. The day’s sales outstanding ratio was high (77.74). This shows that the debtors take a long period time to pay their debt. It shows that the company is experiencing difficulties in collecting debt. The ratio is unfavorable. The day’s inventory was 24.84. Further, the payable period was 29.46 days. These three ratios are favorable. The fixed asset turnover ratio was 1.47. The total asset turnover ratio was 0.61. These two ratios are unfavorable. Therefore, the ratios in this category are inconsistent. The efficiency of the company cannot be generalized based on these ratios. Finally, a conclusion cannot be made on the overall performance of the company because these three categories of ratios are not consistent.

References

Atrill, P. (2009). Financial management for decision makers. United States: Pearson Publishers.