Obtaining financial industry standard ratios is relatively easy; it simply requires that the individual seeking the information does a little detective work. Public companies publish their financial statements, enabling individuals to get the information they need to then plug those numbers into ratios to find out about the overall financial health of an organisation. This allows potential investors to assess a company's financial stability.
- Skill level:
Things you need
- Company names
- Financial statement
- Ratio formulas
Calculate the liquidity ratio. Liquidity ratios explain if a business has enough cash on hand, or access to enough cash, to cover its debts. Banks trying to figure out whether to lend the business money or not want this information because it lets them know whether or not they will be paid back on time, if at all. Examples of two liquidity ratios are:
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = Current Assets - Inventory / Current Liabilities
The higher the value of the ratio, the better the company can cover its short-term debts.
Calculate profitability ratios. Profitability ratios indicate how well the business is at making a profit. The return on assets ratio is calculated by taking net income and dividing it by total assets. This illustrates how efficiently the business is using its assets to generate income. The higher the ROA, the better.
Calculate asset turnover ratios. These explain how well the organisation uses the assets it has. The two most commonly used ratios utilise accounts receivable and inventory:
Receivables Turnover = Annual Credit Sales / Accounts Receivable
The result is the number of days between the firm sending a bill and collecting payment from the client. The lower the number of days, the better.
Inventory Turnover = Cost of Goods Sold / Average Inventory
This ratio explains the cost of goods that are sold in a given time period based on how much inventory there is in that same time period. The higher the inventory turnover, the better, as inventory sitting in a warehouse does not contribute to a business' bottom line.
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