# How to calculate financial ratio analysis

Financial Ratio: Lists, Formulas, and Interpretations

Aug 15,  · A financial ratio is an integral part of the financial analysis of the company. In a rating or stock analyst report, you will find a myriad of ratios. Likewise, banks also use various ratios to measure the financial health of a company. The ratio gives them a guide for drawing conclusions. Nov 20,  · The last group of financial ratios that business owners usually tackle are the profitability ratios as they are the summary ratios of the 13 ratio group. They tell the business firm how they are doing on cost control, efficient use of assets, and debt management, which are three crucial areas of .

By Madhuri Thakur. The financial ratios used in ratio analysis technique are broadly categorized into the following four major categories:. The formula of some of the major liquidity ratios are:. These ratios indicate whether the company has the capability to meet its long-term obligations by comparing its debt level with its assets and equity etc. The formula of some of the major solvency ratios are:.

These ratios indicate how efficiently a company is able to utilize its available assets or convert its inventories to cash. The formula of some of the major efficiency ratios are:. The formula of some of the major profitability ratios are:. Let us take the example of Apple Inc. As per the latest annual report, the following information is available. Based on the given information, calculate the liquidity, solvency, efficiency and profitability ratios of Apple Inc.

Source Link: Apple Inc. Balance Sheet. One of the major uses of ratio analysis is that it makes it easier and simpler to compare companies with different scale of operations. Further, it also simplifies the analysis of the financial statements and helps in identifying deviation in historical trends. This is a guide to Ratio Analysis Formula. Here we discuss how to calculate the Ratio Analysis Formula along with practical examples. We also provide a downloadable excel template.

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Definition

May 23,  · 1. Current ratio -- It's current assets divided by current liabilities, and is a good measurement of how well-covered your short-term liabilities are. A higher current ratio is a Author: Matthew Frankel, CFP. What are my business financial ratios? A regular review of your company's financial ratios can help you focus on areas that may need improvement. Liquidity, efficiency, and profitability ratios, compared with other businesses in your industry, can highlight any strengths and weaknesses you might have over your competition. 3. An activity ratio relates information on a company's ability to manage its resources (that is, its assets) efficiently. 4. A financial leverage ratio provides information on the degree of a company's fixed financing obligations and its ability to satisfy these financing obligations. 5. A shareholder ratio describes the company's financial condition in terms of amounts perFile Size: KB.

Business owners tend to dislike the financial management of their firm. Who can blame them!? It certainly isn't as fun as marketing or advertising or developing an e-commerce site. But, there is one thing about learning about the financial management of your business firm.

It is absolutely necessary. So, you gotta suck it up and learn it. This first financial ratio analysis tutorial, the first in a series of tutorials on financial ratio analysis I'm writing, will get you started. This tutorial is going to teach you to do a cursory financial ratio analysis of your company with only 13 ratios.

Yes, with only 13 financial ratios, you can get a pretty good idea of where your company stands. Of course, you need either past financial statements to compare your current financial statements against or you need industry data.

In this tutorial, I'll use past financial statements and do a time-series analysis. Maybe in another tutorial, I'll show you how to do a cross-sectional with industry financial ratio analysis.

Here is the balance sheet we are going to use for our financial ratio tutorial. You will notice there are two years of data for this company so we can do a time-series or trend analysis and see how the firm is doing across time. Here is the complete income statement for the firm for which we are doing financial ratio analysis. We are doing two years of financial ratio analysis for the firm so we can compare them.

Refer back to the income statement and balance sheet as you work through the tutorial. The first ratios I recommend analyzing to start getting a financial picture of your firm measure your liquidity or your ability to convert your current assets to cash quickly. They are two of the thirteen ratios. Let's look at the current ratio and the quick acid-test ratio. The current ratio measures how many times you can cover your current liabilities.

The quick ratio measures how many times you can cover your current liabilities without selling any inventory and so is a more stringent measure of liquidity. Remember that we are doing a time series analysis, so we will be calculating the ratios for each year.

This means that the company can pay for its current liabilities 1. Practice calculating the current ratio for Your answer for should be 1. A quick analysis of the current ratio will tell you that the company's liquidity has gotten just a little bit better between and since it rose from 1. Divide the result by Total Current Liabilities. For , the answer is 0. Like the current ratio, the quick ratio is rising and is a little better in than in The firm's liquidity is getting a little better.

The problem for this company, however, is that they have to sell inventory in order to pay their short-term liabilities and that is not a good position for any firm to be in. This is true in both and This firm has two sources of current liabilities - accounts payable and notes payable.

They have bills that they owe to their suppliers accounts payable plus they apparently have a bank loan or a loan from some alternative source of financing.

We don't know how often they have to make a payment on the note. Asset management ratios are the next group of financial ratios that should be analyzed. They tell the business owner how efficiently they employ their assets to generate sales. Assume ALL sales are on credit. A receivables turnover of 14X in means that all accounts receivable are cleaned up paid off 14 times during the year.

For , the receivables turnover is The receivables turnover is rising from to We can't tell if this is good or bad. We would really need to know what type of industry this firm is in and get some industry data to compare to. Customers paying off receivables is, of course, good. But, if the receivables turnover is way above the industry's, then the firm's credit policy may be too restrictive. Average collection period is also about accounts receivable. It is the number of days, on average, that it takes a firm's customers to pay their credit accounts.

Together with receivables turnover, average collection helps the firm develop its credit and collections policy. From to , the average collection period is dropping. In other words, customers are paying their bills more quickly. Compare that to the receivables turnover ratio.

Receivables turnover is rising and average collection period is falling. This makes sense because customers are paying their bills faster. The company needs to compare these two ratios to industry averages. In addition, the company should take a look at its credit and collections policy to be sure they are not too restrictive. Take a look at the image above and you can see where the numbers came from on the balance sheets and income statements. Along with the accounts receivable ratios, we analyzed in Step 5, we also have to analyze how efficiently we generate sales with our other assets - inventory, plant and equipment , and our total asset base.

The inventory turnover ratio is one of the most important ratios a business owner can calculate and analyze. If your business sells products as opposed to services, then inventory is an important part of your equation for success. If your inventory turnover is rising, that means you are selling your products faster. If it is falling, you are in danger of holding obsolete inventory.

A business owner has to find the optimal inventory turnover ratio where the ratio is not too high and there are no stockouts or too low where there is obsolete money.

Both are costly to the firm. For this company, their inventory turnover ratio for is:. This means that this company completely sells and replaces its inventory 5. In , the inventory turnover ratio is 6. The firm's inventory turnover is rising. This is good in that they are selling more products.

The business owner should compare the inventory turnover with the inventory turnover ratio with other firms in the same industry. The fixed asset turnover ratio analyzes how well a business uses its plant and equipment to generate sales. A business firm does not want to have either too little or too much plant and equipment. For this firm for For , the fixed asset turnover is 1. The fixed asset turnover ratio is dragging down this company. They are not using their plant and equipment efficiently to generate sales as, in both years, fixed asset turnover is very low.

The total asset turnover ratio sums up all the other asset management ratios. If there are problems with any of the other total assets, it will show up here, in the total asset turnover ratio. For , the total asset turnover is 0. The total asset turnover ratio is somewhat concerning since it was not even 1X for either year. This means that it was not very efficient.

In other words, the total asset base was not very efficient in generating sales for this firm in or It seems to me that most of the problem lies in the firm's fixed assets. They have too much plant and equipment for their level of sales. They either need to find a way to increase their sales or sell off some of their plant and equipment.

The fixed asset turnover ratio is dragging down the total asset turnover ratio and the firm's asset management in general. There are three debt management ratios that help a business owner evaluate the company in light of its asset base and earning power. Those ratios are the debt to assets ratio, the times interest earned ratio , and the fixed charge coverage ratios.

Other debt management ratios exist, but these help give business owners the first look at the debt position of the company and the prudence of that debt position. The first debt ratio that is important for the business owner to understand is the debt to assets ratio; in other words, how much of the total asset base of the firm is financed using debt financing.

For example. In , the debt ratio is In , the business is using more equity financing than debt financing to operate the company. We don't know if this is good or bad since we do not know the debt to assets ratio for firms in this company's industry. However, we do know that the company has a problem with their fixed asset ratio which may be affecting the debt to assets ratio.

The times interest earned ratio tells a company how many times over a firm can pay the interest that it owes. Usually, the more times a firm can pay its interest expense the better. The times interest earned ratio for this firm for is:. The times interest earned ratio is very low in but better in

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