Business
Financial Ratios
Financial ratios are quantitative measures used to assess a company's financial performance and health. They provide insights into various aspects of a business, such as profitability, liquidity, solvency, and efficiency. Common financial ratios include the debt-to-equity ratio, return on investment, current ratio, and gross margin ratio, which are used by investors, creditors, and management to make informed decisions.
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11 Key excerpts on "Financial Ratios"
eBook - PDF- Sudanshu Pandeya(Author)
- 2023(Publication Date)
- Society Publishing(Publisher)
The ratios we’ll talk about are quite well-liked, probably because people think they help make decisions (Juan-Pierre, 2010). 3.2. FINANCIAL RATIO CLASSIFICATIONS Aspects of financial performance or position can be represented by categories of ratios, each of which has a specific relationship to the other categories. Listed below are five categories of Financial Ratios which assist in evaluating the financial well-being of a business: • Profitability: Obviously, the core purpose of a business is to bring money to the owner. The degree to which one will be successful in accomplishing this objective can be predicted with the help of profitability ratios. Profit is often expressed as a proportion of other major metrics found in the financial statements. • Efficiency: Ratios can be utilized to gauge how well certain resources, for example, inventories or staff, have been utilized inside the company. The term “activity ratios” is another name for efficiency ratios. • Liquidity: A company must have enough liquid resources on hand to pay for maturing commitments to survive. The relationship between liquid assets kept and sums that must be paid soon is examined via liquidity ratios. • Financial Gearing: These ratios are interested in the connection between the financial contribution provided by third parties in the form of loans and the owners’ financial contribution to the company. They aid in exposing how heavily the company depends Introduction to Financial Management 80 on loan financing. It is generally believed that the gearing ratios have a massive impact on the return and risk related to the firm (Hussey and Hussey, 1999; Welc, 2022). • Investment: The investment ratios offer the benchmark of the share performances and returns from the viewpoint of shareholders who do not actively participate in the operation and handling of the company. These shareholders do not have a say in the daily operations of the business.
eBook - PDF- Timothy Mayes(Author)
- 2020(Publication Date)
- Cengage Learning EMEA(Publisher)
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. CHAPTER 3 Financial Statement Analysis Tools 76 Ratios are useful to both internal and external analysts of the firm. For internal pur- poses, ratios can be useful in planning for the future, setting goals, and evaluating the performance of managers. External analysts use ratios to decide whether or not to grant credit, to monitor financial performance, to forecast financial performance, and to decide whether to invest in the company. We will look at many different ratios, but you should be aware that these are, of necessity, only a sampling of the ratios that might be useful. Furthermore, different analysts may calculate ratios slightly differently, so you will need to know exactly how the ratios are calculated in a given situation. The keys to understanding ratio analysis are experience and an analytical mind. We will divide our discussion of the ratios into five categories based on the informa- tion provided: 1. Liquidity ratios describe the ability of a firm to meets its short-term obligations. They compare current assets to current liabilities. 2. Efficiency ratios describe how well the firm is using its investment in various types of assets to produce sales. They may also be called asset management ratios. 3. Leverage ratios reveal the degree to which debt has been used to finance the firm’s asset purchases. These ratios are also known as debt management ratios. 4. Coverage ratios are similar to liquidity ratios in that they describe the ability of a firm to pay certain expenses. 5. Profitability ratios provide indications of how profitable a firm has been over a period of time. One additional category, relative value ratios, will be discussed in Chapter 9 on page 292.
eBook - PDFCorporate Finance
Theory and Practice in Emerging Economies
- Sunil Mahajan(Author)
- 2020(Publication Date)
- Cambridge University Press(Publisher)
Ratio Analysis | 299 Ratio Analysis Financial statements are like a fine perfume, to be sniffed but not swallowed. —Abraham Brillof Corporations are complex entities which witness a constant interplay of the policies of the management with the external environment, leading eventually to financial outcomes. At times, the financial outcomes are in accordance with the objectives of the company; at other times, the two may diverge. Whether the desired outcomes are being realized or not, the management needs to continually analyse the performance of the company and consider ways to improve upon it. Ratio analysis is a tool that is extensively used to scrutinize the performance of a company. Its extensive usage is a reflection of the easy understanding and wide applicability of the concept. A ratio is an arithmetical relationship between two numbers, the numbers being usually picked from the accounting statements. It is important to pick numbers that have a meaningful relationship with each other and whose ratio reveals some key performance parameters of the company. Else, the ratio would be irrelevant, even misleading. All stakeholders—shareholders, bond holders, bankers, suppliers, employees, customers and, above all, the management—use ratios to monitor various aspects of the performance of the company. Different stakeholders use different ratios, appropriate to their specific requirements. Investors in the stock market are interested in market-based ratios such as the price earnings (P/E) ratio and the market price to book value ratio. Long-term lenders value leverage and debt service coverage ratio. Short-term lenders prefer liquidity and, therefore, are keen to know the current ratio and the quick ratio. No single ratio or set of ratios can be appropriate for all occasions and purposes. The ratios we calculate and analyse should be appropriate for our objectives, be it performance evaluation, credit analysis or equity investment.
eBook - PDFFinancial Analysis in Hong Kong
Qualitative Examination of Financial Statements for CEOs and Board Members (Second Edition)
- Benny K. B. Kwok(Author)
- 2013(Publication Date)
- The Chinese University of Hong Kong(Publisher)
Chapter 4 Accounting Ratios This chapter gives an overview and brief interpretation of accounting ratios from various perspectives and includes the following sections: • Ratios from Accounting Records and Financial Statements • Profitability Ratios • Liquidity Ratios • Leverage Ratios • Investment Ratios • Accounting Ratios from Listed Corporations’ Financial Highlights As a concept in mathematics, ratios refer to the proportional relationship between two (or more) items, expressed in terms of numbers or percentages. By placing one number over another, a ratio can be computed from any pair of numbers. The top number is called the numerator, and the bottom number is the denominator. We use ratios every day. We compare our weight to the average measurement by relying on a sample of individuals at our age with their total weights divided by the sampled number of individuals. In reading the economy’s unemployment rate, we check the number of people out of work against the total workforce. Ratios measure the size of one item in relation to another item and provide a sense of how changing one item may affect the other one. Grasping this simple concept is vital to analyse what goes on behind the numbers. 58 Financial Analysis in Hong Kong (Second Edition) Ratios from Accounting Records and Financial Statements Accounting ratios are based on accounting books and records and extract relevant figures from corporations’ financial statements. By focusing attention on certain key aspects of a corporation’s financials, accounting ratios generally attach meaning and significance to figures which are not readily apparent from financial statements. For example, if a corporation increases its annual turnover from $1,000 million in 2011 to $1,100 million in 2012, it is simpler and probably more intuitively helpful to state that the turnover has gone up by 10% (= 100% × [1,100 – 1,000] / 1,000).
eBook - PDF- Henry E. Riggs(Author)
- 2022(Publication Date)
- Springer(Publisher)
For example, since Federated borrows substantial amounts, both short term and long term, a ratio of the two might be useful; although that is not a ratio commonly used. Calculating ratios is somewhat analogous to performing a medical examination on a patient. Both the financial analyst and the medical doctor are looking for signs of strength and signs of weakness or disease. Very often these analyses—Financial Ratios or medical diagnostics— 80 UNDERSTANDING THE FINANCIAL SCORE suggest other tests or investigations to yield more useful information. And not every ratio is useful in every situation. Account values bounce around a good bit, financial period to financial period—what electrical engineers call noise in the system. That is, not every small shift in dollar amounts is significant. Accordingly, there is no point in calculating ratios to three or four significant figures; two are typically plenty. With practice you will learn to calculate ratios in your head, rather than on a calculator. You will not read financial statements as you would a book, from left to right, top to bottom of the page. Instead, you will relate various values as you peruse the statements. Categories of Ratios While there are endless ratios, we can classify them into about five categories: a114 Liquidity a114 Utilization of working capital a114 Capital structure a114 Profitability a114 Cash adequacy This chapter illustrates these ratios using Federated’s financial statements that appear in Chap- ters 1, 2 and 6. LIQUIDITY RATIOS The question here is how able the corporation is to meet its near-term obligations: pay salaries, discharge accounts payable, pay interest on borrowing, and so forth. Current Ratio The current ratio is kind of the granddaddy of all ratios: current assets divided by current liabilities.
- Michael Chibili(Author)
- 2019(Publication Date)
- Routledge(Publisher)
This understanding is of primary importance because without it, however precise the calculations are, they will have no meaning. Ratios permit the creation of new, much more meaningful and useful information that goes beyond the facts and figures found in financial statements. On its own, a financial ratio says nothing. When put in its proper context, a financial ratio can permit an analyst to have a good overview of a company’s performance and any upcoming trends. Additionally the ratios on their own will not be able to say whether a situation was acceptable or unacceptable except when these ratios are compared to other data and standards. This means that ratios have to be looked at in the context of other information and experiences. Note however that ratios permit analysts to cope with changes over time in absolute amounts as well as to compare organizations of different sizes. In hospitality organizations the stakeholders (essentially the investors, creditors and the management) will have different perspectives when considering the ratios that result from the analysis of the financial statements. Investors would use the ratios to evaluate the performance of the hospitality organization. The ratios might permit them to be able to make judgments as to the dividends policy of the organization. The creditors make use of ratios to assess how solvent the organization is and if it will be able to pay back its debts in the future. Creditors will most of the time even use ratios to set conditions before credit is provided to the organization. The management will use ratios to help them evaluate the attainment of their objectives and monitor their performances. Standards A standard is generally considered to be a basis for comparison. This can be seen as a point of reference against which other things can be evaluated, and it might relate to quality levels, behaviour levels or units of measurements.
eBook - PDFFinancial Intelligence for IT Professionals
What You Really Need to Know About the Numbers
- Karen Berman, Joe Knight, John Case(Authors)
- 2008(Publication Date)
- Harvard Business Review Press(Publisher)
Ratios don’t require any complex calculations. To figure a ratio, usually you just divide one number by another and then express the result as a decimal or as a percentage. All kinds of people use all kinds of Financial Ratios in assessing a busi-ness. For example: • Bankers and other lenders examine ratios such as debt-to-equity, which gives them an idea of whether a company will be able to pay back a loan. • Senior managers watch ratios such as gross margin, which helps them be aware of rising costs or inappropriate discounting. • Credit managers assess potential customers’ financial health by in-specting the quick ratio, which gives them an indication of the cus-tomer’s supply of ready cash compared with its current liabilities. • Potential and current shareholders look at ratios such as price-to-earnings, which helps them decide whether a company is valued high or low in comparison with other stocks (and with its own value in previous years). In this part we’ll show you how to calculate many such ratios. The abil-ity to calculate them—to read between the lines of the financials, so to speak—is a mark of financial intelligence. Learning about ratios will give you a host of intelligent questions to ask your boss or CFO. And of course, we’ll show you how to use them to boost your company’s performance. The power of ratios lies in the fact that the numbers in the financial state-ments by themselves don’t reveal the whole story. Is net profit of $10 million a healthy bottom line for a company? Who knows? It depends on the size of the company, on what net profit was last year, on what net profit was ex-pected to be this year, and on many other variables. If you ask whether a $10 million profit is good or bad, the only possible answer is the one given by the woman in the old joke. Asked how her husband was, she replied, 146 RATIOS “Compared to what?” As a leader in information technology, you need to identify the ratios that are relevant to your job.
eBook - PDF- Walter Reid, D R Myddelton(Authors)
- 2017(Publication Date)
- Routledge(Publisher)
FINANCIAL STATUS RATIOS Ratios of financial status measure a company’s ability to meet its liabilities. They can be divided between: Solvency ratios – dealing with long-term liabilities. Liquidity ratios – dealing with short-term liabilities. Please refer again to the 2005 accounts of Precision Locks Limited (opposite, left) and calculate the following financial status ratios. Then turn to the next page, and compare your answers with the ratios shown there. As you calculate the ratios, consider what they mean and how they contribute to your appraisal of the company’s financial status. SOLVENCY RATIOS 2005 2004 Debt ratio Debt = = 20.0% Capital employed Interest cover Profit before interest and tax = = 7.0 times Loan interest LIQUIDITY RATIOS Current ratio Current assets = = 2.5 times Current liabilities Acid test Liquid assets (debtors + cash) = = 1.05 times Current liabilities 43 SOLVENCY RATIOS Debt Debt 100 Debt ratio: = = = 18.2% Capital employed Debt + Equity 550 Debt is 18 per cent of the capital employed, which means (in this simple case) that equity is the other 82 per cent. This relatively low debt ratio (‘gearing’) gives lenders a fairly high level of safety (‘equity cushion’). Another way of measuring the same thing is the ‘debt/equity’ ratio: Debt Debt 100 = = = 22.2% Shareholders’ funds Equity 450 Both these gearing ratios are common, so it is important not to confuse them. Bank overdrafts are legally repayable ‘on demand’, and appear under ‘Creditors due within one year’. But both bank overdrafts and any current portions of long-term debt represent negotiated interest-bearing finance. They may best be regarded as part of a company’s interest-bearing capital employed. They contrast with ‘spontaneous’ sources of funds, normally not bearing interest, such as trade credit or tax payable. The net debt ratio uses ‘debt less cash’, in this case 100 – 40 = 60.
eBook - PDF- Michael Broadbent, John M. Cullen(Authors)
- 2014(Publication Date)
- Butterworth-Heinemann(Publisher)
64 Managing Financial Resources Summary of Financial Ratios Liquidity ratios Current assets Current ratio = Current liabilities A . , X M . , v M Current assets - stocks Acid test (quick) ratio = Current liabilities Profitability ratios R QQ E _ Profit before interest and tax (operating profit) Capital employed _ A - « , - , Net profit on ordinary activities before tax Return to shareholders = - — —-f———-(pre tax) Shareholders funds _ . _ , , - , Net profit on ordinary activities after tax Return to shareholders = - — — ^ (post tax) Shareholders' funds Gross profit Gross profit ratio = Operating profit ratio Net profit ratio Turnover _ Operating profit Turnover Profit on ordinary activities before tax Turnover Efficiency ratios Stock (or average stock) n f s r . Stock turnover = 1 A t , x 365 Cost of sales Debtors (or average debtors) Debtors turnovers = χ 365 Turnover Trade creditors _ Creditors turnovers = —— — x 365 Total credit purchases (NB: Total credit purchases is not available from published accounts, so cost of sales is used as a proxy.) Turnover Fixed asset turnover = Fixed assets Investment ratios Long term loans Gearing = (either) Shareholders' funds Assessment of company performance 65 Gearing = (or) Long term loans Capital employed Interest cover = Operating profit Interest charges Stock market ratios Profit on ordinary activities after taxation Number of shares in issue Market price of share Price earnings = (P/E ratio) E P S , w . , , Dividend per share Dividend Yield = — ^ — — — Market price of share The use of accounting ratios for inter-firm comparison While accounting ratio analysis does provide a technique that can be applied to intra-firm and inter-firm comparisons, there are inherent problems in the application of such a technique. The prob-lems arise mainly from the different methods of interpreting the basic concepts and conventions of accounting as presented in Chapter 2.
eBook - PDF- Maire Loughran(Author)
- 2020(Publication Date)
- For Dummies(Publisher)
In other words, an asset costing $1,000 can never be depreciated for more than $1,000. So, factoring in any alternative financial accounting methods in use, ratios over a period of several years should be somewhat consistent, which permits the financial statement user to do some useful trend comparisons. Using trend analysis means looking at profitability ratios over a number of years. Doing so is usually more helpful to the financial statement user than any single ratio is because everything is relative. Seeing how profitability ratios go up and down (when comparing current performance to past performance and when com-paring the company with other companies in the same industry) is more mean -ingful than just looking at one stand-alone ratio. Most investors consider at least five years — sometimes up to ten. Focusing on return on investment Return on investment (ROI) is a measuring tool investors use to see how well their investment in a particular company is faring — and to help them make that important decision to sell a stock and move on or to stick with it. Potential inves -tors also use ROI when trying to make a decision among different companies in which to plunk their spare cash. 226 PART 5 Analyzing the Financial Statements Basically, investors want to see how well company management is using the com -pany assets to make money. This information gives the investor some idea of the competency of management and the relative profitability of a business when compared to others the investor is considering. Investors can calculate ROI, which is expressed as a percentage, a few different ways. All the methods involve using some form of comparing income to assets. Here are two methods your financial accounting textbook most likely illustrates: » Net income divided by average total assets: Net income (see Chapter 10) is the bottom-line total of what’s left over after you deduct all business expenses and losses from all revenue and gains for the same financial period.
eBook - PDFFamily Business by the Numbers
How Financial Statements Impact Your Business
- N. Schwarz(Author)
- 2017(Publication Date)
- Palgrave Macmillan(Publisher)
10 Financial Ratios and Analysis Tools Refined Figures “I t seems to me that we have already gained a pretty good pic- ture of what’s going on with the company,” Greg observed. “Why do we need to go through yet another kind of analysis?” “It’s true that the Balance Sheet and the Income and Cash Flow Statements provide detailed information about a company,” Holmes conceded. “Annual reports typically stop there, and rela- tively few people look any further. Nevertheless, just as the Cash Flow Statement helped us see some aspects of the company in a new light, so these additional calculations, based on figures from the other statements, will sharpen our understanding of specific strengths and weaknesses in the company.” “Judging from the items under ‘Liquidity,’ I’d say that section offers refinements of the Cash Flow Statement,” Sue observed. “That’s basically right,” Holmes agreed. “More specifically, it measures the company’s ability to pay its bills as they come due. The ‘Operating’ section is a different look at the company’s profitability.” “Since we’re not looking at physical safety here, I assume that we’re looking at financial soundness in the ‘Safety and Leverage’ section,” Greg added. “Yes. That section provides a slightly different point of view: how a banker might look at the company while deciding about 90 FAMILY BUSINESS BY THE NUMBERS extending a loan. Of course, we can look at that section to help us appraise the way the company is being financed and, thus, how sound it is.” Liquidity “Now that seems a bit peculiar to me,” Sue protested. “We seem to have plenty of assets, so why should there be any question of the company’s financial soundness?” “Remember the definition of ‘liquidity’: the ability to quickly turn assets into cash,” Holmes reminded her.
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