Ratio analysis is the comparison of line items in the financial statements of a business. Ratio analysis is helps to compare a number of issues with a company, such as its liquidity, efficiency of operations, profitability, and gearing. This type of analysis is useful to analysts outside the business, since the remote source of information about an organization is its financial statements. Ratio analysis is less useful to corporate insiders, who have access to detailed operational information about the organization Online available at: (https://www.myaccountingcourse.com › Financial Ratio Analysis).
According to (http://www.zenwealth.com/businessfinanceonline/RA/ProfitabilityRatios.html), profitability ratios attempt to measure the firm’s success in generating income. These ratios show the rippling effect of the company’s asset and debt management. Profitability ratios are the most used ratios in investment analysis. These ratios include present margin ratios, such as gross, operating and net profit margins. These ratios examine the company’s effort to generate an adequate return. When analyzing a firm’s margins, it is always reasonable to evaluate them against those of the industry and its close rivals. Margins will vary among industries Online available at: (http://www.zenwealth.com/businessfinanceonline/RA/ProfitabilityRatios.html).
Online available at: (https://www.myaccountingcourse.com/financial-ratios/return-on-assets), states that return on assets ratio indicates the dollars in income earned by the firm on its assets. It is necessary to recognize that the ratios are based on accounting book values and not on market values. Thus, it is not proper to compare the ratios with market rates of return such as the interest rate on Treasury bonds or the return earned on an investment in a stock.
As it can be seen, the Reece Group’s ratio is 25 and 24 percent for 2017 and 2016 business years respectively. In other words, every dollar that Reece Group invested in assets during the year 2017 produced $.25 cents of net income. Depending on the economy, this can be a healthy return rate no matter what the investment is (Author’s Construct, 2018).
Online available at: (https://accountingexplained.com/financial/ratios/return-on-equity), posit that return on equity is the ratio of net income of a business during a year to its average shareholders’ equity during that year. It evaluates the profitability of shareholders’ investments. It depicts net income as a percentage of shareholders’ equity.
Investors must evaluate the return on equity of different companies and also compare the trend in return on equity over time. But, depending only on return on equity for investment decisions is not safe. A high return on equity shows that a company is more successful in generating cash internally. However, it does not necessarily mean the risk is associated with that return. A firm may depend much on debt to make an outstanding net profit, thereby increasing the return on equity higher. A 36 and 37 ROE percentage for both 2017 and 2016 business years is normal for generating cash for the Reece Group internally (Author’s Construct, 2018).