Financial Ratios
Financial ratios provide more of an overview. They help management to monitor the company’s performance over a period of time, perhaps a week or a month. In order to fully appreciate and properly use the financial ratios, it is important that the analyst:
- Understand the business and its products
- Analyze the company’s performance within the context of the economic climate
- Be aware of the legal and regulatory issues that the company faces
- Look at the ratios within the context of the competitive Environment
- Be knowledgeable about industry averages and ratio behavior
People with a wide variety of interests may use financial ratios to analyze the business. These include:
External
- Security analysts
- Potential and existing stockholders
- Bankers and other lenders
- Suppliers and their credit managers
- Competitors
- Regulators
Internal
- Board of directors
- Senior management
- Operations, sales, finance, human resources, marketing
- Strategic planners
Each of these groups has its own perspectives and needs. Developing a marketing strategy requires an understanding of the company’s financial ability to support growth. Suppliers assess the company’s ability (not its willingness) to pay its bills in accordance with agreed-upon credit terms
Ratios must be evaluated within their context. The value of statistical indicators has been discussed. Many business and environmental factors have been identified. As mentioned previously, the most valuable use that can be made of ratios is to look at them as part of a trend and to compare them with the same ratios for competitors.
Financial ratios can be divided into four major groupings:
1. Liquidity ratios
2. Working capital management ratios
3. Measures of profitability
4. Financial leverage ratios
There are many different ratios, and their exact definitions vary. What follows is an extensive description of the key ratios, presented with very workable definitions.
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Next: Liquidity Ratios |