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.
8 Key excerpts on "Financial Ratios"
eBook - ePub- David Horner(Author)
- 2020(Publication Date)
- Kogan Page(Publisher)
...Profitability is concerned with looking at the profits earned in relation to some other variable such as sales or capital. Analysing profitability involves looking at how the firm is generating profit, or its potential to generate future profits. We can use accounting ratios to help us assess how well a firm is performing. An accounting ratio is the comparison of two or more pieces of financial data which, once combined, aim to give much more meaningful and useful information about business performance. In this chapter we will consider what each ratio indicates in terms of assessing business performance and how it is calculated. Types of accounting ratio There are many different accounting ratios which can be calculated and they all attempt to enable us to interpret business performance. The different ratios can be categorized according to what particular aspect of business performance they are designed to assess. Although there is no definitive method of classifying ratios, the following groupings are fairly typical: Profitability ratios: Assess measures of profits in relation to sales, capital and other financial variables. Efficiency ratios: Assess how well the firm manages its current and non-current assets and liabilities in terms of their efficient management. Liquidity ratios: Assess the ability to pay its short-term debts without running into cash flow difficulties. Gearing ratios: Assess the long-term capital structure of the business in terms of the relative quantities of debt and equity capital. Investor ratios: Assess the performance of the business in terms of returns for shareholders. Profitability ratios For most businesses, especially limited companies which have one eye on shareholder satisfaction, the profit earned for a period is the key indicator of business success...
eBook - ePub- Brümmer LM, Hall JH, Du Toit E(Authors)
- 2017(Publication Date)
- Van Schaik Publishers(Publisher)
...In general, we can say that Financial Ratios may be divided into four basic groups: Liquidity ratios Activity ratios Debt or solvency ratios Profitability ratios In addition, the liquidity, debt and activity ratios are often used to measure risk. The remaining group of ratios – the profitability ratios – is generally used to measure the organisation’s returns or profitability. Once these calculations have been made, they may be compared with the results of other organisations operating over the same timespan in the same industry as our organisation. Such a comparison is known as cross-sectional analysis – that is, taking a cross-section of the industry’s results and comparing our organisation’s results with them. The organisation’s results may also be compared with its own results, taken over previous years. Such a comparison is known as time-series analysis – that is, an analysis of own results taken over a series of time periods. These results provide an indication of how the organisation has been progressing over the years, and whether it is performing as successfully as other organisations in the industry. Both cross-sectional and time-series analyses may be combined to give a clearer and broader picture of how the organisation is doing. A third form of comparative analysis is to use what are termed “proforma” financial statements. Just as an organisation’s financial statements are based on past or historic results, the proforma statements are based on future or expected results, and would normally be obtainable from the organisation’s budget for the following year. Ratio analysis may then be applied to the proforma statements, after which the proforma ratios may be compared with those arising from the organisation’s current financial statements...
- Matan Feldman, Arkady Libman(Authors)
- 2011(Publication Date)
- Wiley(Publisher)
...CHAPTER 8 Financial Ratio Analysis Introduction What Is Financial Ratio Analysis? Ratios express a mathematical relationship between two quantities and can appear in the form of a: Percentage (%) Rate (greater than, equal to, less than) Proportion (numerator/denominator) Financial ratio analysis (often referred to as ratio analysis) utilizes ratios and relationships between various financial statement accounts as basic tools to compare operational, financial, and investing performance of companies over time and against one another. Ratios are often classified into four categories: Liquidity Ratios As discussed in Chapter 6, liquid assets are those that can be converted into cash within one year, while current liabilities are those that are due within one year. Accordingly, liquidity ratios measure a firm’s short-term ability to meet its current obligations. Common liquidity ratios include: Current ratio Quick (acid) test Current cash debt coverage ratio Current Ratio Current Assets/Current Liabilities The current ratio compares a company’s current assets to current liabilities and measures its ability to cover short-term (maturing) obligations. Quick (Acid) Test (Current Assets - Inventories)/Current Liabilities This is similar to the current ratio, with the only exception of netting out inventories from current assets...
eBook - ePub- Bijan Vasigh, Javad Gorjidooz(Authors)
- 2016(Publication Date)
- Routledge(Publisher)
...The current ratio is a commonly used measure of short-run solvency and presents the ability of a firm to meet its short-term debt requirements as they come due. The quick ratio is a more conservative measure of liquidity. That is, the quick ratio assumes inventory is not very liquid; therefore, it should not be counted. Financial leverage ratios measure the use of debt financing. The debt ratio is the ratio of total debt to total assets; it measures the percentage of funds provided by creditors. Analysis of leverage ratios provides insight on a company’s capital structure as well as the level of financial solvency a firm has. The debt-to-assets ratio is the most basic leverage ratio, measuring the percentage of a company’s total assets that is financed by debt. The debt to equity ratio measures the amount of debt capital a firm uses compared to the amount of equity capital it uses. Each of these different types has specific sub-types which cater for the measurement and analysis of ratios using only the values provided in the financial statements of firms. Toward the end of the chapter, a specific index, known as the Altman insolvency index is discussed, which is a measure used to analyze the bankruptcy status of a firm. The last section in the chapter covers aviation based ratios which convey the financial and managerial standpoint of airlines. CASM, RASM, and RRPM are financial standpoint ratios, while ASL and block hour utilization refer to the efficiency in operations of airlines. Discussion Questions and Problems 14.1 Fuel performance for a given flight can be influenced by many factors. Explain what might be some variables that impact airlines’ fuel efficiency. 14.2 How do you calculate working capital? 14.3 Your airline has an equity multiplier of 2.50. What is its debt-to-equity ratio? 14.4 An airline has an ROE of 30 percent. The industry average ROE is 15 percent...
eBook - ePubNavigating the Business Loan
Guidelines for Financiers, Small-Business Owners, and Entrepreneurs
- Morton Glantz(Author)
- 2014(Publication Date)
- Academic Press(Publisher)
...The truth is – lenders do not in fact pore over financial statements until their credit support teams produce ratios. So if you were hoping for a seamless trip through the loan process, be patient. Ratios form the structure of fundamental analysis, and establish the basis of preliminary loan discussions, so prudent lenders will likely defer further discussion until they have had a chance to review your firm’s ratios. Before you meet with your lender, learn what ratios are all about, what they say about your business, and how to make them work in your favor. What are ratios? A ratio compares values and reveals how much of one measure there is with respect to another measure. If you tell your lender the firm made $2 million profits last year, do not be disappointed if your lender is unimpressed. The value – $2 million – is in fact an absolute number floating in space. However, $2 million profits on $10 million sales means every dollar in sales produced two cents profits, a relative measure of performance that means something. Ratios simplify absolute numbers by converting numbers to a common scale. However, useful as they are, ratios cannot tell the full story. Ratios offer clues, not direct answers. It would be unreasonable for you to think that the mechanical calculation of one ratio or a group of ratios automatically yields factual information about your business. Only you can evaluate past performance, assess the firm’s present position, and obtain a relative value to compare with competition. Does your company earn a fair return? Can it withstand downturns? Does it have the financial flexibility to qualify for low-cost loans or attract additional investors? Is your management team adroit in its efforts to upgrade slow operations, reinforce strong ones, pursue profitable opportunities, and push value to the highest possible levels? Ratios are indeed imperfect, so plan your response ahead of time...
eBook - ePubReturn on Investment Manual
Tools and Applications for Managing Financial Results
- Robert Rachlin(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...As previously discussed, ROI is derived from the two major financial statements, namely, the statement of income and the balance sheet. Therefore, it is possible to group ratios into three major categories. These categories highlight trends at different levels of the organization, much like an organization chart. Each category focuses on a different responsibility level within the organization and relates to different parts of the business and different financial statements. Performance ratios. These follow the trend of the overall performance of the company. Because these ratios are viewed by the outside community as a way of measuring both current and potential performance, they are important to the overall success of the company. Managing ratios. These assist in evaluating the various components of the balance sheet and are used in managing such major areas of the company as cash, receivables, inventories, and debt relationships. Profitability ratios. These evaluate components of the earnings statement and effectively show how well a manager is performing, given his or her level of responsibility. The following examples of the three categories of ratios utilize the financial data presented in Tables 2-1 and 2-2, in chapter 2. Performance Ratios Net income to shareholders’ equity measures the return generated from the owners’ equity in the business when considering all risks. This ratio is important because it serves as a barometer with which shareholders can measure future growth and, ultimately, provide additional capital in the form of buying a piece of the equity, such as shares. The greater the ratio, the more attractive the stock to outside investors. Net income Shareholders’ equity = $ 50, 000 $ 171, 000 = 29.2 % Net sales to shareholders’ equity measures the amount of sales volume supported by the equity of the company. A proper balance must exist, and this balance will be reflected over a period of time...
eBook - ePubThe Power of Accounting
What the Numbers Mean and How to Use Them
- Lawrence Lewis(Author)
- 2012(Publication Date)
- Routledge(Publisher)
...Indeed, quite the opposite is often true. In 2008, Acme had a P/E ratio of 16.39:1 ($50 ÷ $3.05). A copy of selected portions of Columbia Sportswear Company’s 10-K report for 2009 is shown in Appendix A. The annual report on Form 10-K includes audited financial statements and footnotes. Together they provide a comprehensive overview of the company’s business and financial condition. Federal securities laws require publicly traded companies such as Columbia Sportswear to disclose this information on an ongoing basis. Summary Managers as well as investors and creditors can improve their understanding and the performance of a firm’s operations and prospects by developing their ability to analyze and understand financial statements. This chapter presents Financial Ratios as a means of analyzing and gaining insight into the operations of a firm. Ratios show the relationship of one item to another. In order for a ratio to be relevant there needs to be a significant relationship between the two items it compares. This chapter breaks ratios down into four types: liquidity, which measures a firm’s ability to meet current ongoing financial obligations; activity, which measures how actively a firm uses its various resources; leverage, which compares its debt and equity financing; and profitability, which relates a firm’s profit to some factor involved in the earning process. Financial ratio analysis relies heavily on comparison of data. The more relevant comparisons an analyst or manager can make, the more insight and understanding he or she will have. For a thorough analysis, an individual firm’s ratios need to be compared with other ratios...
eBook - ePub- Mick Broadbent, John Cullen(Authors)
- 2012(Publication Date)
- Routledge(Publisher)
...3 Assessment of company performance DOI: 10.4324/9780080496269-3 The Aims of this Chapter are to: Explain why Financial Ratios are appropriate for analysing company performance. Develop financial measures which will assist in the analysis of a company’s liquidity, profitability, efficiency and investment through ratio analysis. Apply the ratios to evaluate company performance using inter- and intracompany comparisons. Consider the ratios used by financial markets in assessing company performance. Consider the limitations of ratio analysis in general and the particular effect individual company accounting policies may have on this analysis. Introduction The external statements considered in Chapter 2 were the end product of an accounting data collection and accumulation process. Information had been filtered and moulded by the set of measurement rules known as the concepts and conventions, supported by the Statements of Standard Accounting Practice (SSAP), Financial Reporting Standards (FRS) and company law to produce the financial statements contained in the annual report and accounts. While the balance sheet, profit and loss account and cash flow statement of a particular company may be used by its particular stakeholder groups, they provide information in isolation from other companies, and a limited comparison of performance over time (usually the current year’s results and the previous year’s for comparison purposes). The broad aim of this chapter is to provide tools of analysis which will aid comparison between companies (interfirm comparison) and within a company (intrafirm comparison) over time. The area of study for this chapter is illustrated in Figure 3.1. The figure illustrates the flow of accounting data to the stakeholders. We have already considered that this data is not specifically designed for particular user needs, but is highly general in nature. In this chapter we will attempt to develop and adapt the information to be more user-specific...
