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Acc 561 Wk 2 Financial Statement Analysis

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Acc 561 Wk 2 Financial Statement Analysis
ACC/561
Businesses, creditors, analysts, and investors use companies’ financial ratios to
assess the financial health of companies. Financial ratios are standard sets of values
calculated from financial statements (Horngren, Sundem, Stratton, Burgstahler, &
Schatzberg, 2008). Different standard financial ratios measure different financial
attributes of a business. This document presents the Quick, Current, DuPont, Profit
Margin, Asset Utilization, and Financial Leverage ratios. The standard ratios can
compare the financial well-being of different companies in a uniform manner for
comparison purposes. Three companies were selected for comparison of financial
ratios in different industries. One company, ING Group (ING), has headquarters
located outside of the United States (U.S.). The two U.S. companies selected are
Microsoft and General Electric (GE).
Quick Ratio
The quick ratio assesses a company’s ability to apply its liquid assets against its
outstanding current liabilities. Expected quick ratios are 1.0 or higher. Lower quick
ratios may indicate liquidity problems. Service businesses usually carry lower quick
ratios than manufacturing and retail businesses. Note that ING is a service business
and does not have inventory.
Current Ratio
The current ratio measures a company’s liquidity. The current ratio is a liquidity ratio
that represents an organization’s capability to repay short-term loans or debt
(University of Phoenix, 2008). Generally, current ratios of 1.5 are common in most

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manufacturing companies. Significantly higher current ratios may indicate a company
is not making efficient use of its assets to produce revenues or to grow the business.
Current ratios approaching 1.0 may have trouble meeting its short-term debt
obligations. Manufacturers of simple products can quickly build and sell its’ products
will generally carry a lower quick ratio. Microsoft, when in production can convert
inventory to sales quickly and therefore can carry a lower current ratio without
financial problems. In contrast, GE’s product build cycle is much longer, therefore will
display a higher quick ratio. ING is a service business, and because it has fewer
assets and no inventory by design than a manufacturing company, its current ratio is
expectedly lower than Microsoft’s and GE’s current ratios.
Dupont Ratio
The Dupont ratio, also called return on equity, encompasses three parts: operating
efficiency, asset use efficiency, and financial leverage. Because of data included in
the ratio, some industries may not find this calculation useful. This ratio may be more
useful within one industry to compare companies. Generally companies expect a
10% Dupont ratio. High-volume sales industries, such as the retail business will
produce a much lower Dupont ratio.
Profit Margin
Profit margin is a measure of how much of a company’s sales dollars are kept by the
company and how well a company controls costs. Profit margins in the retail industry
can be very small, especially in grocery retailing. Grocery stores often operate on
less than 4% profit margin. Manufacturing companies vary significantly. GE derives
much of its profit margin from spare parts and services but do not realize large profit
margins, if any, on their major products (General Electric, 2011). ING in the service
industry generally does not realize profit margins equaling the manufacturing
industry like that of GE or Microsoft.
Asset Utilization
The asset utilization ratio is a measure of revenue earned per dollar of assets. The
measurement indicates a company’s efficiency in the use of its assets to generate
revenue. Microsoft’s assets utilization is unusually high as compared to most
manufacturing companies. Service businesses with a low amount of assets will

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experience higher asset utilizations than heavily capitalized manufacturing
companies.
Financial Leverage
Financial leverage, also known as debt to equity ratio, is a measure of the use of the
tools available to create financial opportunities. Borrowing money can be used to
generate additional revenue. If an entity borrows heavily to produce more revenue or
to attain additional assets, its debt to equity ratio will rise, indicating the entity is more
leveraged than before borrowing the money. Retail and service businesses, without
large amounts of capital equipment will generally have lower financial leverage ratios
than those of the manufacturing industry. Typical manufacturing companies’ debt to
equity ratios are about 1.5. The service industry displays debt to equity ratios of less
than 1.0.
Sample financial ratios are calculated in the table below for Microsoft, GE, and ING.
IASB and FASB
The International Accounting Standards Board (IASB) is a governing body that
publishes International Financial Reporting Standards (IFRS) also called
International Accounting Standards (International Financial Reporting Standards,
2011). Each country has a group that reviews new accounting standards issued by
the IASB. In the United States, this group is known as the Federal Accounting
Standards Board (FASB) (FASB, 2011). General Accepted Accounting Principles
(GAAP) is a set of accounting standards created by each country. Each country can
have a unique GAAP. Each country also has an FASB-like group reviewing new
accounting standards issued by the IASB for potential incorporation into their own
GAAP. Companies that follow their own country’s GAAP produce financial
statements in a uniform manner and format. This uniformity in financial statements
helps in the comparisons of companies’ financial statements.
FASB and IASB standards differ in several meaningful aspects (Huckabay, 1999).
One major difference is the IASB standards focus on how changes in economic
resources affect changes in financial statements whereas the FASB standards allows
interpretation of why changes occurred in a company’s financial statements. Second,

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