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Ratios And Ratio Analysis

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Ratios & Ratio Analysis Reading a company’s financials requires a deep understanding of financial statements and relationships between them. Calculating different performance indicators from the statements requires knowing each sector/segment in them. Finally, the numbers by itself do not say anything specific or definitive about a company because numbers need to be compared to the historical figures of the same company, competitors and an industry. Ratios and their analysis are helpful in revealing at least part of a story, but as with the statements’ numbers ratios by itself are not useful until they compared to the historical ratios of a company and to other companies within the industry. There are four categories of ratios: • Profitability …show more content…

— Return on Invested Capital (simple form) = Net Income – Dividends / Invested Capital — Free Cash Flow Margin = Free Cash Flow / Net Sales — Earnings per Share = Net Income – Preferred Dividends / Average Common Shares Outstanding • Leverage Ratios — Debt to Equity (simple form) = Total Liabilities / Stockholder’s Equity — Interest Coverage = Operating Income / Interest Expense • Liquidity Ratios — Current Ratio = Current Assets / Current Liabilities — Quick Ratio (simple form) = Current Assets – Inventory / Current Liabilities — Cash Ratio = Cash + Cash Equivalents / Current Liabilities • Efficiency Ratios — Inventory Turnover = Cost of Goods Sold / Average Inventory — Days in Inventory = 360 / Inventory Turnover — Accounts Receivables Turnover = Net Sales on Credit / Average Accounts Receivables — Accounts Payable Turnover = Cost of Goods Sold / Average Accounts Payable — Total Asset Turnover = Net Sales / Total Assets • Valuation Ratios — Price/Earnings = Stock Price / Earnings per Share — Price/Sales = Stock Price / Sales per Share — Price/Book = Stock Price / Book Value — Price/Earnings Growth = Projected P/E Ratio / 5-Year EPS Growth Rate — Dividend Yield = Dividend per Share / Stock …show more content…

First, any ratio must be computed correctly. It means, that we should now how a ratio was computed before making any conclusions. As with the numbers in the financial statements any ratio can be calculated to look more favorable. Second, any ratio by itself is meaningless unless we know a company’s industry. In addition, we should know what strategy a company is pursuing. Otherwise, looking at low leverage and liquidity ratios while a company is aggressively expanding and using every possible way to finance that, may lead us to the wrong assumptions. Third, comparing current ratios with the past ones should include any conditions that directly affect a company’s performance from the inside and outside. For example, economic conditions (recession); maybe an industry has changed; or maybe a company was sold, merged, went through bankruptcy or CEO stepped down; maybe a company from a hardware manufacturer became a service company like Xerox or IBM; even things like currency exchange rates do affect a company’s performance. Fourth, benchmarking a company to other companies requires a careful selection of competitors. Not only the size matters, but also if the products or services are similar (Dell & Apple, while in the same industry, do not have the same products except sharing the category – computers). Moreover, a different business strategies these companies are using matter. Fifth,

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