When a company prepares its financial statements at the end of every year to study its financial analysis, it’s not a piece of cake for all the stakeholders. For preparing insightful financial statements, one requires a complete knowledge of every aspect of accounting and financing. Financial Ratio Analysis offers a simple interpretation of complex numbers. It is a thorough tool that gives you insights into the execution of the plans set for the year. It offers efficiency, profitability, flexibility and sustainability to the firm. Financial Ratio Analysis consists of elements from the balance sheet and the income statement. Every ratio gives powerful insights into where you lack or excel in that area.
Ratio analysis is a quantitative method of gaining deep insights into a company’s finances, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is an essential part of fundamental equity analysis. It marks how a company is performing over time, also comparing a company to another within the same industry or sector to get better understanding.
Investors and analysts utilizes ratio analysis to derive powerful insights into the financial health of companies and businesses by scrutinizing past and current financial statements. Comparative data is used to demonstrate how a company/business is performing over time and also can be used to estimate the future performance of the company. This data can also be used to compare a company’s financial position with industry averages, along with measuring how a company holds up against other competitors within the same sector.
Ratios are comparison points for companies to evaluate their financial performance. They are used to evaluating stocks within an industry. In the same way, they measure a company’s current financial health against its historical numbers. Having a good understanding of these ratios will give you a comprehensive view of the company from different angles and help you spot potential red flags and to work on them.
There are various kinds of financial ratios available and can be broadly categorized into the following six types, based on the sets of data they are provided:
Liquidity ratios measure a company’s ability to pay off its short-term debts as and when they become due, using the company’s current assets or liquidity. Liquidity ratios include the current ratio, quick ratio, and working capital ratio.
Solvency Ratios are also known as financial leverage ratios. Solvency ratios compare a company’s debt levels with its assets, equity, and also earnings, to evaluate the chances of a company/business staying afloat over the long haul, by paying off its long-term debt as well as the interest on its debt while also taking care of employee salaries and other expenses.
These ratios tell how well a company can generate profits from its operations. In simple terms, profitability ratios give insights on how long the company can stay in business.
Also called activity ratios, efficiency ratios evaluate how well a company uses its assets and liabilities to generate sales and maximize its profits. Key efficiency ratios include: turnover ratio, inventory turnover, and days’ sales in inventory.
Coverage ratios measure a company’s ability to make the interest payments and other obligations associated with its debts. Examples include the times interest earned ratio and the debt-service coverage ratio.
These are the most commonly used ratios in fundamental analysis. They include dividend yield, P/E ratio, earnings per share (EPS), and dividend payout ratio. Investors use these metrics to predict earnings and future performance.
Financial ratio analysis play a crucial role in simplifying the interpretation of financial statements, detecting potential threats, and facilitating comparisons with competitors. By choosing appropriate financial ratios, businesses can align their analysis with their specific goals, whether it’s profitability, efficiency, liquidity, or leverage. Each ratio provides valuable insights, helping companies understand their financial health and make informed decisions for future growth and stability.
If this is very difficult to understand and seems like a tedious job to be done, Shrink Consulting is at your rescue. We take care of things you don’t want to! Pay a visit today and lets take that tedious financial tasks off your hands.
When you work with Shrink, you always have a committed accounting consultant who provides you with personal service and intelligent technical solutions.
F1/276, Block C, Devli, Sangam Vihar, New Delhi, Delhi 110080
Satisfied with the advice
Satisfied with the advice
Just drop in your details here and we’ll get back to you!
