FINANCIAL STATEMENT ANALYSIS

Essay
Rubrics: A total of 10 points each. 7 points for content; 3 points for construction

a. What is benchmarking? How is it important for a firm to have a benchmark when analyzing its financial
statements?
Benchmarking is the comparison of performance criteria and business processes of a firm with
those of other firms in the same industry. Finding the greatest performance in a firm, a competitor
or a completely new industry can be accomplished by benchmarking. As a result of this
information, an organization's procedures can be improved to gain a competitive advantage.
Benchmarking and financial ratio analysis can throw light on issues that are hindering your
business's performance. Comparisons and ratio analysis will help you to understand how your
company's financial performance compares to others in the industry.
b. Current ratio is usually used to assess the firm’s overall liquidity however, what circumstances would
the quick ratio be preferred over it?
When all of the firm's current assets are liquid, the current ratio is a better liquidity measure.
Quick ratio is the better measure if the firm's inventory isn't readily convertible to cash. It is
possible to measure the liquidity of a firm using the current ratio of the firm and by using its
short-term liquidity ratio. As a result, it is considered to be the more precise method of measuring
the firm' To put it another way, the current ratio "explains" the relationship between. As long as
current assets are able to manage current liabilities, the firm's liquidity would be good. Stocks and
pre-paid expenses are examples of assets that cannot be converted into cash quickly. There is no
problem with prepaid expenses but what about stock? If we measure liquidity on the basis of
current assets converted into cash, there are many firms where conversion of stock into cash is not
possible very often. There are several reasons for this. The first is the inability to easily sell off
large quantities of using the current ratio as a measure of a company's liquidity is always
recommended in this situation. Those firms, on the other hand, where stock can be easily realized
or sold off, should not consider stock when measuring liquidity. For example, inventories of a
service sector company are very liquid because there are no stocks kept for sale. Taking another
example where stocks make up a large portion of current assets, we can see that in order to
determine the liquidity of a firm, stocks are necessary. On the other hand, where stock contributes
a relatively small amount, it can be avoided and liquidity of that firm can be measured with the
help of quick ratio. However, in situations where the price of the stock fluctuates a lot, it is always
better to compute the quick ratio and avoid the stock figure because it will reduce the validity of
liquidity measure.
c. Explain why balance sheet accounts are generally “averaged” and income statement figures are just
lifted from the income statement when using them as factors in a particular financial statement ratio?