Ratio Analysis

This paper seeks to outline the relationship of an article appearing in Financial Times under the title “Borrowing cost remain high” by Davies to the chapter topic on ratio analysis. The article by Davies is talking about the bank rates that still remain high to assure investors that business entities could borrow during these times of financial crisis .

These high interest rates have remained very high even after the different central banks or monetary authorities of the world may have announced that they have acted together to bring down the interest rates as a response to the feared problem in the world’s financial system that might eventually result to world recession. The fact of such high interest rates used by banks in lending each other is still being felt in the tensions created in the money markets despite several pledges to bring in additional capital the world’s governments through the banking system or by way of making or giving guarantees to different types of bank debts.

Among the central banks or monetary various of the biggest governments in the world which have made their pledges include the United States, the United Kingdom and those from Europe. The issue of high borrowing cost is very much related with the issue of ratio analysis in finance since management people view business in terms of how the company’s cost of capital is related with the interest rates from the banking system.

Companies would normally use interest rate as standard in meeting the entities financial objectives which are measurable by financial ratios. These financial ratios include those of profitability, investment, liquidity and solvency. Since financial ratios are basically based on historical accounting, financial managers would use the same in adjusting said information in relation with the interest rates in the market.

Interest rates increase in the market as evidenced by high inter-bank borrowing rates would require bank to adjust the cost of capital in making future plans that would require debt financing. This could mean therefore higher cost of capital which may force them to adjust their profit targets, liquidity targets and capital structure targets. They know that high interest rates are being used as well by government to address inflation which the companies will use also in adjusting their cost of capital. High inflation has the effect of understating computed cost of capital.

The issue of borrowing cost or interest rates as referred in the article is viewed by analysts that while the moves of government to infuse capital through the banking system by guarantees or loans have caused some positive development in the stock markets and had brought down the cost of insuring bank loans against possible failure to pay in the United States , the reactions of the business community were not that abrupt as to show restoration of confidence level that the businessmen had before the financial crisis.

These analysts would like to believe that the effect of reduced cost of doing business would be a gradual one. These analysts have based their opinions on the behaviour of Libor rates. To cite an instance, the three-month Libor rate has shown an almost nil movement in the sterling markets, although the UK government has guaranteed the same. Analysts have just found lowering of sterling three-month Libor rate by 2 basis points at about 6. 25%. The same experience was noted for euro three-month Libor rate which has remained high at 5. 25 percent.

What was worth noting was the apparent lack of clear reaction from the money market despite the much announced move of government guarantee in history of banking. Could it mean a deeper problem of financial crisis that how the governments have responded so far? It can be concluded that the topic of ratio analysis is very much relevant with the issue of financial crisis. It is said that what can be measured, can be managed. Similarly companies use ratio analysis to measure the performance of their business in the same manner that the world governments are managing the world economy out of the financial crisis.