Ratio Analysis Essay

Words: 2586
Pages: 11

Financial Reporting II
Review of Ratio Analysis

Ratio analysis is a useful tool for analyzing financial statements. Calculating ratios will aid in understanding the company’s strategy and in understanding its strengths and weaknesses relative to other companies and over time. They can sometimes be useful in identifying earnings management and in understanding the effect of accounting choices on the firm’s reported profitability and growth. Finally, the ratios help in obtaining a better understanding of a firm’s current profitability, growth, and risk which can improve forecasts of future profitability and growth and estimates of the cost of capital.

In reviewing the basic financial ratios, we will examine the ratios of Best Buy
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Disaggregating the Asset Turnover Ratio
To better understand why the asset turnover ratio changed, the analyst can examine the productivity of important assets such as accounts receivables, inventory, and fixed assets at generating sales.

Accounts Receivable Turnover
The accounts receivable turnover measures the rate at which the firm collects its accounts receivables. The accounts receivable turnover is calculated as follows: Net Credit Sales Average Accounts Receivables

The average number of days’ accounts receivables were outstanding during the period can be calculated by dividing the accounts receivable turnover into 365 days as follows:

365/Turnover = # of days Accounts Receivables were outstanding during the year, on average Best Buy

AR turnover
(247 + 209)/2

= 85.95
4.25 days
(209 + 189)/2

= 77.02
4.74 days
Most of Best Buy’s transactions are for cash or credit cards; therefore, the number of days’ sales outstanding is very small, approximately 4 days.

Inventory Turnover
Inventory turnover measures the average days that the firm’s inventory was on hand during the period. The inventory turnover is calculated as follows: Cost of Goods Sold Average Inventory

The average number of days the inventory was on hand can be calculated by dividing the inventory turnover into 365 days as follows:
365/Turnover = # of days inventory on