December 26, 2013 Articles

Young Lawyer Focus: Using Financial Ratios

Create models that predict financial failure.

By Jeffrey L. Baliban

In the previous installment in this series, we discussed analyzing the financial condition of a business by pulling key ratios from financial statements. Specifically, we showed how, aside from knowing the dollar quantity of assets, debt, or revenues, financial statement data could be used to extract other useful information about the financial condition of a firm, such as the following:

  • Identifying the company’s ability to pay its bills in a timely manner

  • Estimating the extent to which the company could meet a sudden demand for cash

  • Assessing how efficiently asset investments are managed (e.g., is inventory maintained in an effective profit-maximizing manner, or are accounts receivable/payable being managed efficiently?)

  • Determining the sufficiency of assets carried and the extent to which amounts reflect net realizable values for items like inventory and accounts receivable

  • Assessing the benefits and risks of the extent of the company’s leverage (debt)

  • Identifying the uses of debt (e.g., the extent to which the company is financing today’s operations as opposed to investing in the future)

  • Assessing the firm’s ability to access additional capital

  • Understanding the return on debt or equity investments and how investors rate the company vis-à-vis alternative investments

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