How to Calculate Financial Ratios of Performance
Calculating financial ratios of performance is the best way to determine the true value of a potential investment. Financial ratios convert dollars into smaller numbers for further analysis. However, the calculation is just one part of the analysis. These ratios are intended to be compared to competitors’ ratios and to the industry average. It is only in the context of other numbers that the financial ratios become especially meaningful.
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Instructions
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Locate the company's annual report, which can be found on its investor website. Find the balance sheet and income statement, as this is where you'll find the numbers you need to calculate your ratios.
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Calculate the company's current ratio to see how well the company can meet its short-term financial obligations. Divide the company's current assets by its current liabilities. A current ratio greater than 1 means the company is able to fulfill its obligations; a lower ratio indicates that the company may have to borrow money to pay its debts.
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Measure a company's leverage by dividing its total liabilities by its current assets. The result shows how much the company owes in proportion to how much it owns. If a company has a leverage ratio greater than 1, it means the company is using more investor money than its own money; high leverage ratios mean that the company is less likely to get financing in the future. A low leverage ratio means the company doesn't owe much, but it may also mean the company could be missing out on opportunities by not using debt.
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Determine the company's sales-to-receivables ratio by dividing net sales by net receivables. Take this number and divide it into 365 to get the company's days-receivable ratio. The days-receivable ratio shows you how long it takes the company to get reimbursed for its sales. A lower number is favorable; a high days-receivable ratio essentially means that the company's money is being used to float loans to its buyers.
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Calculate the company's return on assets, or ROA, to determine how efficiently the company is using its assets. Divide the company's net income -- its income minus the cost of goods sold -- by its assets. Use this ratio over time to see how a company's ROA changes, as it can vary from year to year. Look for a consistently low ROA when investing in a company.
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Tips & Warnings
These ratios are just a sample of the things you should be looking for when analyzing a company's financial performance. Speak to a financial adviser or broker if you need help interpreting the ratios or other financial figures reported by a company.
