sivapillarisetty.com Weekly Newsletter - 5/6/24 - Key Ratios, Meanings, and formula.
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From Wikipedia, the free encyclopedia
A financial ratio or accounting ratio states the relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies.[1] If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.
Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percentage value, such as 10%. Some ratios are usually quoted as percentages, especially ratios that are usually or always less than 1, such as earnings yield, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples. Given any ratio, one can take its reciprocal; if the ratio was above 1, the reciprocal will be below 1, and conversely. The reciprocal expresses the same information, but may be more understandable: for instance, the earnings yield can be compared with bond yields, while the P/E ratio cannot be: for example, a P/E ratio of 20 corresponds to an earnings yield of 5%.
Sources of data[edit]
Values used in calculating financial ratios are taken from the balance sheet, income statement, statement of cash flows or (sometimes) the statement of changes in equity. These comprise the firm's "accounting statements" or financial statements. The statements' data is based on the accounting method and accounting standards used by the organisation.
Purpose and types[edit]
Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Liquidity ratios measure the availability of cash to pay debt.[2] Activity ratios measure how quickly a firm converts non-cash assets to cash assets.[3] Debt ratios measure the firm's ability to repay long-term debt.[4] Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.[5] Market ratios measure investor response to owning a company's stock and also the cost of issuing stock.[6] These are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in company's shares.
Financial ratios allow for comparisons
Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare.
Accounting methods and principles[edit]
Financial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices. Most public companies are required by law to use generally accepted accounting principles for their home countries, but private companies, partnerships and sole proprietorships may elect to not use accrual basis accounting. Large multi-national corporations may use International Financial Reporting Standards to produce their financial statements, or they may use the generally accepted accounting principles of their home country.
There is no international standard for calculating the summary data presented in all financial statements, and the terminology is not always consistent between companies, industries, countries and time periods.
Types of Ratio Comparisons[edit]
An important of ration analysis is interpreting ratio values. A meaningful basis for comparison is needed to answer questions such as "Is it too high or too low?" or "Is it good or bad?". Two types pf ratio comparisons can be made, cross-sectional and time-series.[7]
Cross-Sectional Analysis[edit]
Cross-sectional analysis compares the financial ratios of different companies at the same point in time. It allows companies to benchmark from other competitors by comparing their ratio values to similar companies in the industry.
Time-Series Analysis[edit]
Time-series analysis evaluates a company's performance over time. It compares its current performance against past or historical performance. This can help assess the company's progress by looking into developing trends or year-to-year changes.
Abbreviations and terminology[edit]
Various abbreviations may be used in financial statements, especially financial statements summarized on the Internet. Sales reported by a firm are usually net sales, which deduct returns, allowances, and early payment discounts from the charge on an invoice. Net income is always the amount after taxes, depreciation, amortization, and interest, unless otherwise stated. Otherwise, the amount would be EBIT, or EBITDA (see below).
Companies that are primarily involved in providing services with labour do not generally report "Sales" based on hours. These companies tend to report "revenue" based on the monetary value of income that the services provide.
Note that Shareholders' Equity and Owner's Equity are not the same thing, Shareholder's Equity represents the total number of shares in the company multiplied by each share's book value; Owner's Equity represents the total number of shares that an individual shareholder owns (usually the owner with controlling interest), multiplied by each share's book value. It is important to make this distinction when calculating ratios.
Abbreviations[edit]
(Note: These are not ratios, but values in currency.)
Ratios
Profitability ratios
Profitability ratios measure the company's use of its assets and control of its expenses to generate an acceptable rate of return
Gross margin, Gross profit margin or Gross Profit Rate[
Gross Profit/Net Sales?:::OR?:::Net Sales - COGS/Net Sales
Operating margin, Operating Income Margin, Operating profit margin or Return on sales (ROS)
Operating Income/Net Sales
Profit margin, net margin or net profit margin
Net Profit/Net Sales
Return on equity (ROE)
Net Income/Average Shareholders Equity
Return on assets (ROA ratio or Du Pont Ratio)
Net Income/Average Total Assets
Return on assets (ROA)
Net Income/Total Assets
Return on assets Du Pont (ROA Du Pont)[
Net Income/Net Sales?· Net Sales/Total Assets
Return on Equity Du Pont (ROE Du Pont)
Net Income/Net Sales?· Net Sales/Average Assets?· Average Assets/Average Equity
Return on net assets (RONA)
Net Income/Fixed Assets + Working Capital
Return on capital (ROC)
EBIT(1 ? (Tax Rate))/Invested Capital
Risk adjusted return on capital (RAROC)
Expected Return/Economic Capital?:::OR?:::Expected Return/Value at Risk
Return on capital employed (ROCE)
EBIT/Capital Employed
Cash flow return on investment (CFROI)
Cash Flow/Market Recapitalisation
Non-Interest expense/Revenue
Net gearing
Net debt/Equity
Basic Earnings Power Ratio
EBIT/Total Assets
Liquidity ratios[edit]
Liquidity ratios measure the availability of cash to pay debt.
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Current Assets/Current Liabilities
Current Assets ? (Inventories + Prepayments)/Current Liabilities
Cash and Marketable Securities/Current Liabilities
Operating cash flow ratio
Operating Cash Flow/Total Debts
Activity ratios (efficiency ratios)[edit]
Activity ratios measure the effectiveness of the firm's use of resources.
Accounts Receivable/Annual Credit Sales?×?365 Days
Percent Change in Net Operating Income/Percent Change in Sales
Accounts Receivable/Total Annual Sales?×?365 Days
Average payment period
Accounts Payable/Annual Credit Purchases?×?365 Days
Net Sales/Total Assets
Stock turnover ratio
Cost of Goods Sold/Average Inventory
Net Credit Sales/Average Net Receivables
Inventory conversion ratio
365 Days/Inventory Turnover
Inventory conversion period (essentially same thing as above)
Inventory/Cost of Goods Sold?×?365 Days
Receivables conversion period
Receivables/Net Sales?×?365 Days
Payables conversion period
Accounts Payables/Purchases?×?365 Days
(Inventory Conversion Period) + (Receivables Conversion Period) ? (Payables Conversion Period)
Debt ratios (leveraging ratios)[edit]
Debt ratios quantify the firm's ability to repay long-term debt. Debt ratios measure financial leverage.
Total Liabilities/Total Assets
(Long-term Debt) + (Value of Leases)/(Average Shareholders Equity)
Long-term Debt to equity (LT Debt to Equity)
(Long-term Debt)/(Average Shareholders Equity)
EBIT/Annual Interest Expense
OR
Net Income/Annual Interest Expense
Net Operating Income/Total Debt Service
Market ratios[edit]
Market ratios measure investor response to owning a company's stock and also the cost of issuing stock. These are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in company's shares.
Earnings per share (EPS)
Net Earnings/Number of Shares
Dividends/Earnings
OR
Dividends/EPS
Dividend cover (the inverse of Payout Ratio)
Earnings per Share/Dividend per Share
Market Price per Share/Diluted EPS
Dividend/Current Market Price
Cash flow ratio or Price/cash flow ratio
Market Price per Share/Present Value of Cash Flow per Share
Price to book value ratio (P/B or PBV)
Market Price per Share/Balance Sheet Price per Share
Market Price per Share/Gross Sales
Price per Earnings/Annual EPS Growth
Other Market Ratios
Enterprise Value/EBITDA
Enterprise Value/Net Sales
Cost/Income ratio
Sector-specific ratios
EV/capacity
EV/output
https://en.wikipedia.org/wiki/Financial_ratio
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