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Ratio Analysis |
| Revision as of 15:49, February 9, 2009 (edit) Giorgosmich - Director (Talk | contribs) ← Previous diff |
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| *[[Dividend cover]], in times = ( Profit after tax / dividends ) | *[[Dividend cover]], in times = ( Profit after tax / dividends ) | ||
| *[[Dividend yield]] = ( Dividend / Share price ) | *[[Dividend yield]] = ( Dividend / Share price ) | ||
| - | *[[P/E]] = ( Share price / Earnings per share ) | + | *[[P/E]] = ( Share price / [[Earnings per share]] ) |
Revision as of 07:01, February 12, 2009
| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
Financial Ratio Analysis is the calculation and comparison of main indicators - ratios which are derived from the information given in a company's financial statements(which must be from similar points in time and preferably audited financial statements and developed in the same manner). It involves methods of calculating and interpreting financial ratios in order to assess a firm's performance and status. This Analysis is primarily designed to meet informational needs of investors, creditors and management. The objective of ratio analysis is the comparative measurement of financial data to facilitate wise investment, credit and managerial decisions. Some examples of analysis, according to the needs to be satisfied, are:
- Horizontal Analysis - the analysis is based on a year-to-year comparison of a firm's ratios,
- Vertical Analysis - the comparison of Balance Sheet accounts either using ratios or not, to get useful information and draw useful conclusions, and
- Inter-firm Analysis - the analysis is done by using some basic ratios of the Industry in which the firm under analysis belongs to (more specifically, the average of all the firms of the industry) as benchmarks or the basis for our firm's overall performance evaluation.
The informational needs and appropriate analytical techniques needed for specific investment and credit decisions are a function of the decision maker’s time horizon(short versus long term investors and creditors). A pervasive problem when comparing a firm’s performance over time(trend or time series analysis) or with other firms(cross sectional or common size analysis) is changes in the firm’s size over time and the different sizes of firms which are being compared. However, one approach to this problem is to use common size statements in which the various components of the financial statements are standardized by expressing them as a percentage of some base (base in the income statement is sales and base in the balance sheet is total assets). See sample file below for further understanding.
In general, a process of standardization is being achieved by the use of ratios. They can be used to standardize financial statements allowing for comparisons over time, industry, sector and cross sectionally between firms and further facilitate the evaluation of the efficiency of operations and/or the risk of the firm’s operations regarding the scope and purpose of evaluation. Ratios measure a firm’s crucial relationships by relating inputs(costs) with output(benefits) and facilitate comparisons of these relationships over time and across firms.
Many attractive categories of financial ratios and numerous individual ratios have been proposed in the literature. The most prominent literature on financial analysis - though non-exhaustive - indicates the following categories of ratios:
Contents |
Profitability
- Gross Profit ratio = ( Gross profit / Sales ) * 100
- Operating Profit = ( Operating profit / Sales) * 100
- ROCE - Return on Capital Employed, in times = ( Profit before interest and tax / Net Assets )
Financial or Liquidity ratios
- Current ratio, in times = ( Current Assets / Current Liabilities )
- Quick ratio, in times = ( (Current Assets - Stock) / Current Liabilities )
- Gearing ratio = ( Long Term Liabilities / (Total Capital and Reserves + Long term Liabilities ), either in times or as a percentage by multiplying by 100.
- Interest Cover, in times = ( Operating profit / Interest expense )
Activity or Management Efficiency ratios
- Debtors days, in days = ( Av. Debtors / Sales ) * 365
- Creditors days, in days = ( Av. Creditors / COGS ) * 365, where COGS is the Cost of Goods Sold by the firm
- Stock days, in days = ( Av. Stock / COGS ) * 365
Where "Av.", is the Average amount of the opening and closing balance of the corresponding account of the financial year the Analysis is being undertaken.
Market or Investment ratios
- Dividend cover, in times = ( Profit after tax / dividends )
- Dividend yield = ( Dividend / Share price )
- P/E = ( Share price / Earnings per share )
Word of caution: Inflation should be taken into consideration when a Ratio Analysis is being applied as it can distort comparisons
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