Financial Ratio Analysis List of Financial Ratios

To correctly implement ratio analysis to compare different companies, consider only analyzing similar companies within the same industry. In addition, be mindful how different capital structures and company sizes may impact a company’s ability to be efficient. Using financial ratios can also give you an idea of how much risk you might be taking on with a particular company, based on how well it manages its financial obligations. You can use these ratios to select companies that align with your risk tolerance and desired return profile. That results in an interest coverage ratio of 4, which means the company has four times more earnings than interest payments. Equity ratio is a measure of solvency based on assets and total equity.

• For any value investor, you must conduct a level of analysis that is quantitative and removes any emotional component to your investment strategy.
• Then, a company analyzes how the ratio has changed over time (whether it is improving, the rate at which it is changing, and whether the company wanted the ratio to change over time).
• The term “ratio” conjures up complex and frustrating high school math problems, but that need not be the case.
• This need can arise in an emergency situation or in the normal course of business.

Liquidity ratios include the current ratio, quick ratio, and working capital ratio. The inventory turnover ratio indicates the speed at which a company’s inventory of goods was sold during the past year. The low fixed asset turnover ratio is dragging down total asset turnover.

Operating-Margin Ratio

A company may be thrilled with this financial ratio until it learns that every competitor is achieving a gross profit margin of 25%. Ratio analysis is incredibly useful for a company to better stand how its performance compares to similar companies. The interest coverage ratio measures the company’s ability to pay interest. We can calculate it by dividing earnings before interest and tax (EBIT) by interest expense. Example 13
Assume that a company’s cost of goods sold for the year was $280,000 and its average inventory cost for the year was $70,000. Therefore, its inventory turnover ratio was 4 times during the year ($280,000 / $70,000).

It compares a company’s stock price to its earnings on a per-share basis. It can help investors determine a stock’s potential for growth. The total-debt-to-total-assets ratio is used to determine how much of a company is financed by debt rather than shareholder equity. There are significant limitations on the use of financial ratios. First, the information used for a ratio is as of a specific point in time or reporting period, which may not be indicative of long-term trends.

What are Accounting Ratios?

Basically, the P/E tells you how much investors are willing to pay for $1 of earnings in that company. Remember, lenders typically have the first claim on a company’s assets if it’s required to liquidate. Generally, ratios are used in combination to gain a fuller picture of a company. Using a particular ratio as a comparison tool for more than one company can shed light on the less risky or most attractive. Additionally, for a view of past performance, an investor can compare a ratio for certain data today to historical results derived from the same ratio.

This can help them to determine which might be a lower-risk investment. XYZ company has $8 million in current assets, $2 million in inventory and prepaid expenses, and $4 million in current liabilities. That means the quick ratio is 1.5 ($8 million – $2 million / $4 million).

Inventory Turnover Ratio

Efficiency ratios measure how well the business is utilizing its assets and liabilities to create deals and earn profits. They compute the utilization of inventory, machinery utilization, and turnover of liabilities, financial ratios formulas and explanations as well as the use of equity. I created this writeup nearly solely for this analysis of this exact ratio. I love the analysis to find a true value of a dividend growth stock on a go-forward basis.