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Chapter5_Lecture_2page[1] - o Creditors use ratio analysis...

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1 Chapter 5 Ratio Analysis Purpose of Ratio Analysis Ratio analysis indicates the strengths and weaknesses of a hospitality firm by calculating basic relationships. A ratio is the mathematical expression of the relationship between two financial and/or operating figures. A single ratio in itself is meaningless since it does not furnish a complete picture. The ratio becomes meaningful when compared with ratios from a past period, industry averages, or budgeted ratios. Ratio analysis has become an integral part of most computerized financial analysis programs, demonstrating its widespread use. Managers, creditors, and investors often have different purposes in using ratio analysis to evaluate the information reported in financial statements. o Managers use ratios to monitor the operating performances of their operations and evaluate their success in meeting various goals. ± Example 1: In a food service operation, most managers compute food cost percentage and labor cost percentage in order to monitor the two largest expenses. ± Example 2: In lodging operations, occupancy rate is one of the key ratios. 2 o Creditors use ratio analysis to evaluate the solvency of hospitality operations and to assess the riskiness of future loans. ± Example: current ratio (the relationship between current assets and current liabilities) indicates a company’s ability to pay its upcoming bills. o Investors and potential investors use ratios to evaluate the performance of a hospitality operation. ± Example: the dividend payout ratio (dividends paid divided by earnings) indicates the percentage of earnings paid out by the hospitality company. Five Major Types of Ratios Liquidity ratios Solvency ratios Activity ratios Profitability ratios Operating ratios
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3 Liquidity Ratios Short-term solvency Measuring the hospitality firm’s ability to meet its short-term obligations as they become due, normally referred to as the firm’s short-term debt-paying ability or short-term solvency. In the evaluation of liquidity we assume that current assets are used for fulfilling short-term obligations. The primary parties interested in the evaluation of the firm’s current debt-paying ability are the short-term creditors. Lack of liquidity in its extreme form could lead to the dissolution of the hospitality company (i.e., bankruptcy) and thus will affect all financial statement users. Working capital = current assets – current liabilities o An absolute measure of liquidity o Not as effective as the aforementioned ratios Three major relative measures of liquidity in the hospitality industry: current ratio, the quick ratio, and the accounts receivable turnover. 4
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