Overview of Financial Ratio Analysis

The most ideal approach to analyze a financial statement is by studying financial ratios.  Financial ratios help decipher the outcomes and compare with previous years and other companies in the same industry. A typical financial ratio uses information from the financial statement to calculate its value. Accounting policies may vary across organizations and distinctive financial years. Financial ratios can be to some degree characterized into different classifications such as profitability ratios, leverage ratios, valuations ratios, and operating ratios.

These financial ratios help investors to make wise decisions while analyzing a company. An investor needs to have financial statements to analyze these ratios. One can find these reports on SEBI’s website and on RMoney’s website

Financial Ratio Analysis

The Profitability Ratios

It helps the expert to measure the productivity of the organization. This ratio also tells that how well an organization can perform in terms of generating profits. Management’s competitiveness can also be found by this ratio. This is a very important consideration as profits are needed to pay a dividend to shareholders and expansion of business. Some of the profitability ratios are EBITDA margin, PAT margin, Return on Equity, Return on Assets, and Return on Capital Employed, etc.

The Leverage Ratios

It is also known as the solvency ratio that measures the organization’s ability to sustain in the long term its everyday operations. This ratio calculates the degree to which the company utilizes the debt to finance growth. A company has to pay its bills and obligations to sustain its operations. Solvency ratios assist us in understanding the organization’s long-term sustainability, keeping its commitment in perspective. Some of the leverage ratios are Interest Coverage Ratio, Debt to Equity Ratio, Debt to Asset Ratio, and Financial Leverage Ratio.

The Valuation Ratios

The Valuation ratios compare the organization’s stock price with either the profitability of the organization or the organization’s overall worth. It calculates that how pricey or cheap the stock is trading. Hence, this ratio assists us with providing whether the company’s current price is seen as high or low. In easier words, the valuation ratio contrasts the expense of safety and the advantages of possessing the stock. Some of the examples of valuation ratios are Fixed Assets Turnover Ratio, Working Capital Turnover Ratio, Total Assets Turnover Ratio, Inventory Turnover Ratio, Inventory Number of Days, and Receivable Turnover Ratio.

The Operating Ratios

This ratio is also known as the activity ratio that calculates the ability that a business can convert its both current and noncurrent assets into revenues. The efficiency of management of a company can also be found out by this ratio. This is the reason operating ratios are often called management ratios. Some of the operating ratios are the Price to Sales (P/S) Ratio, Price to Book Value (P/BV) Ratio, and Price to Earnings (P/E) Ratio.

Bottom Line

Irrespective of the category these financial ratios belong to convey a certain message, primarily related to the financial health of the company. For instance, ‘Productivity Ratio’ can pass on the organization’s proficiency, which is typically estimated by processing the ‘operating Ratio’. As a result of such overlaps, it is hard to order these ratios. Consequently, the ratios are ‘to some degree loosely’ ordered.