Financial Invoice

Most Important Ratio

Frances Calwile

ACC 205

Debra Touhey

Dec. 17, 2012

According to Walther, investors are especially interested in knowing that businesses that they invest in are capable of producing an eventual profit. As a very broad generalization (and therefore subject too many exceptions), the more profitable a firm is, the more valuable it is. Owning 10% of a business making a total profit of $1,000,000, rather than 1% of a business making $2,000,000 in profits, is more desirable. Thus, it is necessary to evaluate profitability not only in the aggregate but also on a scale, or ratio, basis. (Walther. 2012) According to Walther, investors may also look at the book value per share. This is the amount of stockholders' equity represented by each share of common stock. You should be extremely careful in thinking about book value per share. It is based on the reported amount of stockholders' equity. Remember the fundamental accounting equation: Assets = Liabilities + Equity. Many assets are listed at their cost, not their value. This is a double-edged sword. Some assets may be worth more than their cost and vice versa. This is especially true for recorded and unrecorded intangible assets. Thus, the residual reported equity may not be very reflective of the intrinsic firm value, and calculations of book value per share may be far afield from what the stock would be valued at on a per-share basis. Nevertheless, it is a popular measure. Some investors look to this number as the floor price below which the stock is seen as a bargain. You are cautioned against jumping to this conclusion.

Before you can begin investing in individual stocks, you need to learn how to calculate financial ratios. Even if you decide to get your financial ratios from your broker or financial site, you still need to know what the company represents. Otherwise, you may make a mistake and buy into a company with too much debt, not enough cash to survive, or low profitability. According to Walther, investors are especially interested in knowing that businesses that they invest in are capable of producing an eventual profit. As a very broad generalization (and therefore subject too many exceptions), the more profitable a firm is, the more valuable it is. (Walther. 2012)

References

Walther. (2012). Principles of Accounting: Volume I (1st ed.). San Diego, CA: Bridgepoint Education, Inc.