Financial Ratio Analysis

3. Introduction to Financial Ratios

Financial ratios are dealings determined from a firm's financial information and used for comparison purposes in financial means. Some of the financial ratios are Profitability ratios, Liquid ratios, Capital structure ratios, Assets management ratios and Market value ratios. Sub-categories of these ratios are defined below.

3.1 Profitability Ratios

A category of financial metrics used to evaluate a business's ability to generate profit as compared to its expenses and other relevant costs earned during a specific period of time.

In order to interpret the firm’s profitability by using the income statement, Gross profit margin (GPM), Operating profit margin and Net profit margin needs to be examined.

3.1.1

Working capital is calculated by the following formula:

Working Capital = Current Assets - Current Liabilities

3.2.4 Quick ratio or Acid-test ratio

The acid-test ratio is an indicator of whether a firm has enough short-term assets to cover its liabilities. Acid-test ratio is commonly known as the quick ratio and this metric is more stronger than the current ratio, as it eliminates illiquid assets such as inventory. It’s is calculated as follows:

Quick Ratio = Current Assets – Inventory Current Liabilities

3.3 Asset management efficiency ratios

Asset management (turnover) ratios relate the assets of a firm to its sales revenue. Asset management ratios specify how effectively a company is utilizing its assets to create revenues. Examination of asset management ratios tells how efficiently and effectively a firm is using its assets in order to generate revenues. They specify the ability of a firm to interpret its assets into the revenues. Asset management ratios are also known as asset turnover ratios or asset efficiency

It looks at the amount of time required to sell inventory, the amount of time needed to collect receivables and the length of time the company is have enough money to pay its bills without incurring penalties. It is calculated as follows: Cash Conversion cycle = DIO + DSO – DPO

3.3.7 Fixed Assets Turnover (FAT)

The fixed-asset turnover ratio processes a company's ability to produce net sales from fixed-asset investments most precisely property, plant and equipment (PP&E), depreciation. It is a ratio of net sales to fixed assets. A greater fixed-asset turnover ratio shows that the firm has been more effective in spending the investment in fixed assets to generate revenues.

FAT is calculated as follows: Fixed Assets Turnover (FAT) = Net Sales ____ Average net fixed assets.

3.3.8 Inventory Turnover

Inventory turnover is a ratio presenting how many times a company's inventory is sold and replaced over a period. It is calculated