Application of ratio analysis in enterprise financial

management

Abstract ： In the process of operation and development, in order to obtain more

economic profits, the enterprise needs the financial management and analysis, and
then realizes the shareholder wealth maximization. Ratio analysis is more practical in
financial management. Therefore, this paper analyzes the application of ratio analysis
in enterprise financial management, and points out some noteworthy places in the face
of the limitations of ratio analysis.
Key words：ratio analysis,financial management,enterprise decision

1. The connotation of ratio analysis

Generally, in financial analysis,we should analyze solvency, operation ability and
profitability （ There are other categories certainly, but they don't go beyond these
three dimensions）. The method we usually use is ratio analysis. Ratio analysis is to
process and analyze financial information on the basis of deep understanding of
enterprise operation and management, so as to help enterprises make judgments,
decisions and forecasts. As an effective method and technique, ratio analysis can
reflect the cash flow, financial status and operating results of an enterprise. Through
the implementation of the relevant financial ratio index analysis can provide a
favorable basis for enterprise managers to make decisions.

2. The ratio analysis of three kinds of indicators

2.1 Solvency analysis
Solvency refers to the degree to which an enterprise can guarantee its debts in a
corresponding period, which is deeply affected by the enterprise's liquidity of asset.
Solvency mainly consists of short-term solvency and long-term solvency. The ratio
that reflects short-term solvency mainly involves current ratio, cash ratio and quick
ratio; The ratio that reflects long-term solvency mainly involves debt-to-assets,
interest coverage and equity ratio.
The liquidity of enterprise assets have a subtle influence on the short-term
solvency. The liquidity refers to the transformation of assets without price reduction
and the shrinkage of current assets caused by the transformation. To some extent,
enterprise management efficiency and operation level have a decisive impact on cash
inflow. Current ratio refers to the ratio of current assets and current liabilities.
Generally, financial risks will decrease with the enhancement of short-term solvency
and the increase of current ratio. Otherwise, risks will increase, so the reasonable limit
is particularly important. From a theoretical point of view, “2” of liquidity ratio is
usually understood to be normal, meaning that the financial situation is good; Less
than “1” means that the enterprise has a large financial risk, the repayment of short-
term debt has a certain difficulty; A current ratio higher than “2” means that
enterprises have wasted assets and unreasonable allocation. Long-term solvency needs
to take a long-term view as the starting point and dynamically observe whether an
enterprise can repay the principal and interest on time. For the generation of debt
repayment funds, capital guarantee is the appreciation of the asset, which needs the
support of the normal profitability of the enterprise. The enterprise cannot rely on
selling assets to repay long-term liabilities for a long time. The profitability of the
enterprise is closely related to long-term solvency.
Debt-to-assets refers to the proportion between total liabilities and total assets,
which is an indispensable debt repayment indicator. Taking the conservatism principle
as the starting point, asset-liability ratio of about 50% is understood as a high asset-
liability ratio, which means that the enterprise has a strong ability to raise funds. But
low asset-liability ratio means that the financial risk of the enterprise is smaller. The
enterprise should be clever to clarify the degree of liabilities in combination with the
actual situation and improve profits. Equity ratio refers to the ratio between total debt
and owners' equity. A higher ratio means that the capital structure has higher risks and
higher benefits. The interest coverage is refers to the ratio of EBIT to interest
expense.Interest expense involves financial expenses and capitalized interest. This
ratio exerts a subtle influence on the enterprise debt paying ability, in general
enterprise’s solvency will enhance with the increase of the ratio. To some extent, only
when the ratio is higher than 1 can the enterprise be able to repay the interest expense.

2.2 Operation ability analysis

Activity ratios refers to how efficiently an enterprise can use all its assets based
on the turnover speed of each asset. The strength of operation capacity is not only
reflected in the application ratio of a single asset, but also longitudinal analysis based
on the trend of index change, and horizontal analysis compared with the same
industry. Activity ratios analysis involves accounts receivable turnover, fixed assets
turnover, operating cycle and total assets turnover, etc. Accounts receivable turnover
ratio refers to the proportion between sales and accounts receivable, and days of sales
outstanding is the proportion of the number of days in the whole year and the ratio of
accounts receivable turnover. It means the speed of receivables collection and
management efficiency of an enterprise, so as to infer the profitability and asset
liquidity of an enterprise. First of all, a larger receivables turnover ratio means that the
enterprise can quickly withdraw the sales revenue, which has a higher management
efficiency .Secondly, less receivables means rapid capital turnover. It is likely that the
enterprise has put forward harsh conditions for supply requirements and credit
standards, resulting in a small market share.
Inventory turnover refers to the proportion of COGS and inventory. In general,
high inventory turnover means that companies have large COGS and sell more
products,In other words,the enterprise has a strong sales ability.Inventory turnover
ratio plays a role in measuring whether inventory capacity is reasonable, and it is the
main sign to ensure the supply, production and sales cycle of enterprises. Therefore,
enterprises need to make reasonable adjustments according to the actual situation. In
addition, the speed of capital turnover increases with the decrease of receivables, and
the enterprise credit requirements and supply conditions are too strict, which reduces
the market share to a certain extent. In general, the operation will be accelerated with
the speed of turnover of all assets, and the operation efficiency will be improved with
the shortening of the operating cycle. Asset turnover ratio refers to the proportional
relationship between the revenue and the average total asset value. It is a
comprehensive evaluation of the operating efficiency of an enterprise, and fully shows
the input and output velocity of all assets of an enterprise, as well as a comprehensive
evaluation of the utilization efficiency and management quality of all assets of an
enterprise. Generally speaking, asset turnover has a subtle impact on the operating
capacity of an enterprise, and sales capacity will be strengthened with the increase of
asset turnover. In order to accelerate the speed of asset turnover, some enterprises
choose bulk-cheap to improve their profits.

2.3 Profitability analysis

Profitability refers to the potential or possibility of an enterprise to obtain profits
within a certain period of time. Profit is not only the starting point and destination of
enterprises, but also the source of investors' income. It’s also an important basis for
judging managers' performance and the main guarantee for employees' treatment
improvement. Profitability analysis involves the ratios of gross profit margin, return
on total assets and net profit margin,etc.
Gross profit margin refers to the proportion between gross profit and net
revenue. The use of this ratio needs to fully consider the characteristics of the
industry,the operating cycle, and a reasonable comparison with the same industry, to
find the distance and improve profits. Return on total assets refers to the proportion
between net income and average total assets, which fully demonstrates net profit per
unit of assets. Generally, the management efficiency based on the operation of all
assets will be improved with the improvement of the profitability of the total assets.
The net profit margin is the ratio of net income to revenue,and indicates how much of
per unit of sales left after all expenses. Profitability will increase as the ratio increases.

3.Matters needing attention in the application of ratio analysis

3.1 Make full use of all indicators
In ratio analysis, we should not unilaterally pay attention to the change of a
certain financial index, but consider from various aspects. For example, on the
analysis of short-term solvency, it is necessary to analyze the current ratio, quick ratio
and cash ratio simultaneously, Moreover, It can also be analyzed by the guarantee
degree of monetary funds and cash flow of operating activities on short-term debt. If
monetary funds and cash flow from operating activities cannot guarantee short-term
debt, cash inflow from financing activities can be further analyzed.

3.2 Pay attention to the limitations of ratio analysis

With the development of economy and society, many new economic business
forms and models have emerged, such as group companies, multinational companies,
Internet companies and sharing economy. The group company may have subsidiaries
in different industries and businesses. First of all, from the perspective of data
acquisition, if some data from the consolidated report are selected for ratio analysis,
the reflected situation will be inconsistent with the actual situation. Because such data
is the average, is mixed data.So it’s necessary to increase the granularity of financial
ratio analysis.Secondly, there is a lack of financial analysis tools to analyze the effect
of foreign exchange transactions and foreign exchange risk avoidance in multinational
companies. Finally, some key financial ratio analysis indicators are often focused on
by corporate management and used to sugarcoat and manipulate financial data. It is
very important to identify this kind of financial data fraud behavior through
systematic financial ratio analysis.

3.3 Note the comprehensive understanding of the industrial environment

The current financial ratio analysis can not make a comprehensive reflection to the
operation activities of enterprises. The ratio analysis method is simple and widely
used in practice, but it can only help stakeholders to make a rough judgment. This
rough analysis separates the overall view of enterprise management. The conclusion
obtained through basic ratio analysis has little contribution to the stakeholders and
limited contribution to the improvement of the enterprise operation. In principle, the
business situation of the enterprise will be reflected in the data, but it is still difficult
to reverse the business activities of the enterprise through the financial data in
practice. One of the advantages of the ratio analysis method is to dilute the influence
of different enterprises, which makes it possible to compare enterprises of different
sizes and even in different industries with the same benchmark. However,in the
evaluation of the financial ratio, the data should not be evaluated by data,or simple
comparison of the absolute value of the numbers should not be made. Instead, the
analysis should be carried out in combination with the external and internal
environment of the enterprise to make the ratio analysis more in-depth and the
conclusion more objective.

3.4 Note the important influence of non-monetary measurement on the

development of enterprises
In the process of long-term development of enterprises, the financial situation
can not be completely analyzed and controlled by monetary measurement. Non-
con

monetary factors such as leaders' ideas, corporate culture, managerial competence and
experience, product category and marketing status are equally important. Enterprises
will formulate different development strategies and adjust the strategies of research
and development, production and sales according to the development status.During
the adjustment period, it will affect the costs, expenses, profits and other aspects.
These non-monetary measures have little impact on the financial data in the short
term, but for the long-term development, there will be a large gap. Therefore, not all
financial information needs to rely on monetary measurement to reflect. It is
necessary to analyze all the links and factors that affect the development of
enterprises, and then make effective decisions. Although it costs a lot of time, it can
improve the accuracy of financial ratio analysis and increase the authenticity of
financial statement information.

Conclusion： In summary, financial management plays an extremely important role

in the development of enterprises, and ratio analysis is an indispensable tool for
corporate financial management, so the application of ratio analysis is very important.
It is vital to note that although the ratio analysis has played a relatively active role,
there is also a corresponding disadvantages and limitations. It cannot show
enterprise's actual conditions completely, which requires that enterprises need to make
reasonable analysis on the basis of fully understanding and mastering other indicators,
so as to draw more scientific and objective conclusions and promote the realization of
the maximum benefits of enterprises.