How to Interpret Financial Analysis Ratios

It is essential to carry out analytical evaluations of a business and contrasting of financial figures when accessing a business contracts. There are various categories of rations that will enable one to access the status of a business in various aspects.

Instructions

Difficulty: Challenging

1. These are called Liquidity Ratios analyze and reflect company’s ability to meet its debt obligations when they become due.
2. To understand the basis of the liquidity ratios used; it is important to analyze the type of data used which includes:
   
   • Comparing the company assets that can be easily turned into cash (i.e. liquid assets) in order to meet the maturing debt at that period.
   • Accessing the promptness with which the liquid assets are actually concerted into cash.
   These include: Current Ratio, Acid test /Quick Ratio, Current cash debt coverage ratio, Receivables turnover, Inventory Turnover Ratio, Net Working Capital Ratio and Current Liabilities to Inventory Ratio
3. Profitability Ratios are used to determine if adequate profits are being generated in contrast to the investments planted into the corporation.
4. The profitability ratios are accessed when:
   • The various forms of profits are contrasted to the assets invested.
   • The forms of profit contrasted may include:
   -Gross profit measure profitably before taking into account marketing related expenses
   -Net profit is deduced are taking into account tertiary expenses such as interest etc.
   -Operating profits which are the actual profit generated directly from company productivity which is ideal for assessing profit return on investment.
   These include: Profit Margin Ratio, Cash return on sales Ratio, Asset Turnover Ratio etc.
5. Solvency ratios are used to determine the resources or means the company is using to finance its assets and activities. The objective is to monitor the debts and assets ratio.
6. To access the solvency ratios contrast;
   -The proportion of the company’s total debt to the total company assets to ascertain the debt equity ratio.
   -The operating Income to interest expense to access the firm’s debt servicing capacity.
   These include: Debt/Equity Ratio, Cash debt coverage Ratio, Debt to Total Assets Ratio, Times interest Earned.
7. The Return on Equity Ratios accesses how much the shareholder receive in contrast to their equity contributions to the company i.e. Shareholder’s investments.
8. The various types of shareholders equity and earnings are contrasted against the profit various forms of profits mentions in
   STEP 4. These include: Stockholder’s equity Ratio, Rate of Return on common stock, Earnings per Share Ratio, Price-earnings ratio etc.