52 PART 1 Introduction to Managerial Finance
FIGURE 2.1Combined Analysis
Combined cross-sectional
and time-series view of
Bartlett Company’s average
collection period, 2000–2003
Average Collection Period (days)70605040302000 2001 2002 2003IndustryBartlettYearCombined Analysis
The most informative approach to ratio analysis combines cross-sectional and
time-series analyses. A combined view makes it possible to assess the trend in the
behavior of the ratio in relation to the trend for the industry. Figure 2.1 depicts
this type of approach using the average collection period ratio of Bartlett Com-
pany, over the years 2000–2003. This ratio reflects the average amount of time it
takes the firm to collect bills, and lower values of this ratio generally are preferred.
The figure quickly discloses that (1) Bartlett’s effectiveness in collecting its receiv-
ables is poor in comparison to the industry, and (2) Bartlett’s trend is toward
longer collection periods. Clearly, Bartlett needs to shorten its collection period.Cautions About Using Ratio Analysis
Before discussing specific ratios, we should consider the following cautions about
their use:- Ratios with large deviations from the norm only indicate symptomsof a
problem. Additional analysis is typically needed to isolate the causesof the
problem. The fundamental point is this: Ratio analysis merely directs atten-
tion to potential areas of concern; it does not provide conclusive evidence as
to the existence of a problem. - A single ratio does not generally provide sufficient information from which
to judge the overallperformance of the firm. Only when a group of ratios is
used can reasonable judgments be made. However, if an analysis is con-
cerned only with certain specificaspects of a firm’s financial position, one or
two ratios may be sufficient. - The ratios being compared should be calculated using financial statements
dated at the same point in time during the year. If they are not, the effects of