Analyzing financial statements includes financial ratios - Financial ratios introduction. Financial ratios are key to helping understand the various numbers throughout a financial statement in an organized and comprehendible fashion. It is important to be able to highlight and define the most relevant ratios, while understanding how to compute and interpret the meaning.
Financial ratios are categorized into 5 main categories: 1. Liquidity (demonstrate the ability of a company to pay its bill if operating cash is insufficient to pay short-term obligations) 2. Efficiency (allow investors/employees to analyze how quickly the company is converting its inventory and accounts receivables into cash) 3. Leverage ( is used to measure how a company uses its debt to fund long-term financial needs) 4. Profitability Ratios (used in determining how a company uses its assets in order to generate sales and manage its operations) 5. Market-Value Indicators (takes values from financial statements in order to generate ratios which explain: earnings per share, price earnings ratio, and the market-to-book ratio). These ratios are often compared to industry standards.
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The formula for calculating your liquidity ratio is the current assets divided by current liabilities. The standard for a healthy business is 2, which means that it has twice as many assets as it does liabilities. Here is the liquidity ratio for Abdul Bin Malek: = Current Assets/Current Liabilities
This ratio shows that there at 1.43 times assets as there are liabilities.
Efficiency ratio is a way to measure a company’s ability to turn resources into revenue. The lower the ratio, the better, whereas 50% is generally industry standard as an optimal ratio. Here is efficiency ratio for Abdul Bin Malek: =Expenses/Revenue
This ratio shows that for every $1 earned, it costs the company $.86.
The most important leverage ratio, is a debt-to-equity ratio. Leverage ratios are a great indicator of how much of a company’s assets are paid for with borrowed money. The leverage ratio for Abdul Bin Malek is: =Debt/Equity
If the equity-to-debt ratio is greater than 1 it signifies that the majority of assets are financed through debt. Abdul Bin Malek’s ratio is .046, less than 1, which shows that assets are primarily financed through equity.
Profitability is the main concern of businesses. Profitability ratios are often times used to determine the company’s bottom line and its return to its investors. Here are key profitability ratios for Abdul Bin Malek: Return on sales = net earnings/sales
Industry standard shows return on sales at 5.77% (bizstats.com).
Return on assets = net earnings/total assets
Industry standard shows returns on assets at 5.53% (bizstats.com).
Return on invested capital = net earnings/ (owners equity + long-term debt) =1,881,000/ (11,158,100 + 512,000)
Return on equity = net earnings/ owner’s equity
Lastly, there market-value ratios which indicate the economic status of your company in the wider marketplace. Market value ratios can include: earnings per share, price earnings, book value per share, and market value per share. Market value ratios are applicable to a publicly traded firm. If a company reflects good ratios, then the stock price of the firm should be higher than one that doesn’t. Market value ratios essentially are a different ways to look at the overall relative value of a company’s stock. These are the 5 main categories to consider when analyzing the health of a company. References:
Biz Stats. (2012). Retrieved from http://www.bizstats.com/corporation-industry-financials/transportation-warehousing-48/warehousing-and-storage-493/show Business Finance. (2013). Retrieved from http://bizfinance.about.com/od/financialratios/a/Profitability_Ratios.htm Profitability Ratios for Investment Analysis. (2013). Retrieved from http://www.dummies.com/how-to/content/profitability-ratios-for-investment-analysis.html University of Phoenix. (2010). Reports and Financial Statements . Retrieved from University of Phoenix, Fin/571 website.