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 Critical review on financial accounting

 
With the increasing dynamic business environment, it has been seen that company`s financial performance has been affected by several factors. Although there are many techniques to measure the level of influence and difference made in the financial statements. As per the statement of Trivedi et al., 2016, The tools and techniques include relative valuation technique, common size analysis horizontal, and vertical trend analysis. One of most prominent technique use to examine the financial analysis includes ratio analysis. Ratio analysis is the quantitative measure of getting higher insight into the company's operations. The objectives are quite clear that it locates apprproiate weaknesses by spotting the negative business activities. It is useful in making cross sectional and times series analysis in relation to industry and then to conduct an appropriate comparison between the past ratio and present ratios. The ratio analysis is based on some important criterion profitability, liquidity, efficiency, and solvency. Each of them reflects different perspective of the company's performance. Profitability ratio is the measure of profit generated as the proportion of total revenue. Liquidity ratio brings out the ability of the company to pay off its current liabilities and obligations. 
As per the statement of Zolfani, Yazdani, and Zavadskas, 2018, Solvency ratio is the measure to examine the ability of the company to pay off its long term liabilities. Each ratio is evaluated on the basis of standard ratio and ideal ratio so that company`s worth and its operations can be analysed in accordance to the financial ratios provided. Practical implication states that the company has been accomplishing its liquidity if it maintains current ratio of 2:1. This ratio indicates that the company has two times of current assets to one ratio of current liabilities. Ratio analysis is quite helpful in examining the financial statements because it helps the investors, suppliers, lenders, bankers, and trade payables to acquire appropriate knowledge of financial health of the company. The ratio analysis differs in terms of efficiency between ratios as the tools to examine the financial statements. It may indicate the performance of company to a level but any particular decrease in one current asset and increase in another current asset does not affect the current ratio. On the other hand, it is seen that there will be no difference in current ratio if another current asset (trade receivable) has replaced one current asset (cash). Furthermore, solvency is another important ratio, which is represented as criteria for ability to pay off the long term loans. Ideal debt equity ratio is 2:1 because due to high debt equity ratio there is less dilution of ownership. As per the statement of Camin, Bontempo, and Piasentier, 2016, There will be benefit of tax as tax is deducted while calculating profits. Less number of equity shareholders could have more right on dividends as debt lenders have claim on only principal amount and interest payment. Company could save its time as debt can be raised in less time than equity. Debt is cheaper source and it can replace equity, which appropriately means expensive source of finance. The significance of debt equity ratio evaluates the ability of the organisation in order to accomplish long-term liabilities. This ratio shows the risks associated with the long term funds but at tame, it is not suitable for Construction Company because it employs debentures, which are generally redeemed after 50 years and have long time span since the time, the construction is completed. 
As per the statement of Campisi et al., 2019, this measures overall profitability of firm. This is very important ratio. If it is found low, lots of problem may raise. Company cannot be able to pay dividend, operating expenses. However higher profitability ratio, will protect company from unwanted hindrances and bad economic conditions. Higher the ratio will be better.
 
Net profit ratio 
According to Kogadeeva, and Zamboni, 2016,This measures overall profitability of firm. This is very important ratio. If it is found low, lots of problem may raise. Company cannot be able to pay dividend, operating expenses. However higher profitability ratio, will protect company from unwanted hindrances and bad economic conditions. Higher the ratio will be better. This ratio is gross profit to net sales and showed in percentage form. GPR is also known as turnover ratio. This is mainly important and significant because earning of business can shown by measuring margin between sales and COGS. This margin will be more if ratio is high. As per the statement of Walmsley et al., 2018, Management is always interested in higher gross profit ratio, to cover high operating expenses and interest payment. 20 to 30 Percent ratio is normal for every business. This displays the efficiency of firm in producing goods. More defective purchasing, low selling cost, more investment in fixed asset may cause to low gross profit ratio. Return on equity used to calculate financial performance of company. It is ratio between net income and shareholders’ equity. ROE measures management ability to raise profit from available equity. 15 to 20% return on equity is considered as good. If company tends to more debt than this will increase financial leverage of company, which leads to high Return on equity. More debt and less equity shareholders than ROI is higher (Perini et al., 2018).
As per the statement of Christoph, 2017, efficiency ratios are quite prominent while examining the ability of the company to measure the effectiveness of resources and their employment in the company. This ratio indicates how effectively inventory, working capital, fixed assets, and trade receivables rotates in revenues from the operations. Firstly, a lower efficiency ratio indicates that there is a blockage of funds, lower revenues, lower profits, higher bad debts, and no writing off the bad debts. If the turnover of the company is higher than it does not suffer from low revenues.
According to Zavadskas, Stević, Tanackov, and Prentkovskis, 2018, it is important to know that as each coin has two sides same every model has its own pros and cons. Some of the important limitation of financial ratio states that false data accounting can lead to false ratio. For example- closing inventory has been overvalued, which will lead to fluctuation in the profitability, as it will be overstated and overvalued. As per the statement of Hatzinger, Fuller, Sturchio, and Bhlke, 2019, Unless the prepared financial statements are reliable and correct, the ratios based on financial statements will also be correct. According to Liang, Zhao, and Hong, 2019, the comparison is not possible if different companies adopt different accounting policies. For instance- accounting for deprecation, provision for the doubtful debts, and the valuation of closing inventory. One company can adopt straight-line method and on the other hand, it can use written down method. This will lead to create a difference between the amounts. According to Choi, Lee, Kim, Lim, 2018, It is important to note that there is no absolute thumb rule, which can examine the company`s performance. A single ratio cannot determine financial position as good or bad. With an aim to comment on the quality of the financial ratios, which is then compared to some standards and benchmarks. Ratio analysis avoids the qualitative factors, which are quite important for the analysis as credit may grant to customer based on specific ratios of the business. Lack of apprproiate standards for the ideal ratio as it differs from industry to industry as well as change in circumstances. According to Erasmus et al., 2016, regular investors continuously make investment decision on the basis of intuition as they think that ratios alone are not appropriate proper conclusion because they are not sure indicators of good and bad indicator for the unfavourable position. Window dressing is another important factor affecting and indicating that the company often hide its bad financial statements. For example- changes in the balances of balance sheet reveal that current liabilities of $500000, which has been represented by the company as manipulative. It may lead to decrease in current ratio might be from 3:1 to 1:1 (Rashmi, Shree, and Singh, 2017).   
 
Conclusion
On a concluding note, it is seen that the investors often look at the audited financial statements to examine the financial position of the company. Undoubtedly, ratio analysis is a good measure of acquiring knowledge regarding the performance of the company. Overall, ratio analysis is not another for the investors, they will have to look after historical price analysis, stock price analysis, valuation method, and price to earnings ratio. The critical review of financial analysis has discussed both pros as well as cons. For example- the treatment for transaction may differ according to different accounting aspect such as it may be different in international accounting standard and Australian accounting standard. As ratio analysis, defining each ratio does not come up with each element of ratio by considering fluctuations, which can be disadvantageous because it becomes so succinct for the investors to think on.
 
 

 

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