financial ratios quick overview | learn financial ratio analysis basics #Finance

Accounting systems and Financial Statements and reports are wonderful things but they aren’t worth the software they’re built from nor the paper they’re printed on if no one analyes and interprets them numbers by themselves mean nothing

numbers with context and justification mean everything the whole point of preparing Financial Forecasts and budgets is to attempt to predict future performance while creating baselines by which you can compare actual results if results you experience are as predicted terrific

you’re right on track toward your goals if the actual results are significantly less or significantly more than predicted however it’s time to look for the sources of these variances here are some ways that you can analyze your company’s performance against expectations variance

analysis by comparing your organization’s actual results versus its budgeted results for example your actual Revenues versus budgeted Revenues you get a quick picture of whether your company is on or off track and by how much ratio analysis by comparing

certain Financial results within your company’s financial statement ments particularly the Income statement and Balance Sheet you can determine whether your company is operating within the normal limits for your industry for example dividing your

company’s current Assets by its current Liabilities results in a ratio the quick ratio that tells you whether your company is solvent and can meet its Financial Obligations to your lenders cost volume Profit analysis by determining what

products or services are the most and the least Profitable for your company you can make decisions about where to invest your company’s time and resources there are a couple key approaches to cost volume Profit analysis Break Even analysis A Break Even

analysis be allows you to determine at what sales volume you can earn a Profit after paying all the expenses of producing your product or service be is the point at which the cost of the product or service equals the sales volume everything above that point is gross

Profit using electronic spreadsheets you can run all sorts of what if scenarios with a variety of different cost and price assumptions contribution margin analysis contribution margin analysis compares the Profitability of each of your company’s products or

Services as well as the products or Services relative contribution to your company’s bottom line This analysis quickly points out underperforming products and services that your company should either restructure or terminate if your company is underperforming you can redirect resources to

boost performance or you can change plans to bring your expectations in line with reality if your company is overperforming you can identify the reasons why and do more of the same at the same time you can modify your budgets upward to accommodate the improved performance Liquidity

ratios Liquidity ratios are ratios that measure the solvency of a business its ability to generate the cash necessary to pay its bills and meet other short-term Financial Obligations current ratio the current ratio is the ability of a business to pay its current

Liabilities out of its current Assets here’s how the current ratio Works current ratio equals current Assets divided by current Liabilities in general a ratio of 2.0 or better is good in fact many banks require that their

borrowers maintain a current ratio of 2.0 or higher as a condition of their Loans quick ratio the quick ratio also known as the assid test is a measure of a business’s ability to pay its current Liabilities out of its current Assets however

the quick ratio subtracts inventory out of the current Assets providing an even more rigorous test of a firm’s ability to pay its current Liabilities quickly inventory often is difficult to convert to cash because it may be obsolete or in the case of some

fraudulent practices non-existent here’s how the quick ratio Works quick ratio equals open parentheses current Assets minus inventory Clos parentheses divided by current Liabilities a ratio of 1.1 or higher is considered to be acceptable activity ratios

activity ratios are indications of how efficient your company is at using its resources to generate Revenue the faster and more efficiently your firm can generate cash the stronger it is financially and the more attractive it is to investors and lenders and the less likely it is

that managers will be laid off re rebles turnover ratio the receivables turnover ratio indicates the average amount of time that your company takes to convert its receivables Into Cash the ratio is a function of how quickly your company’s customers and clients pay their bills basically it

points out problems that your company may be having in the collections process here’s how it works receivables turnover ratio equals net sales divided by accounts receivable the higher the ratio the better average collection period you can discover a very interesting piece of information by

using your receivables turnover ratio by dividing 365 days by your receivables turnover ratio you find out the average number of days that your company takes to turn over its accounts receivable this results is known as the average collection period here’s the breakdown average collection

period equals 365 days divided receivables turnover ratio equals 365 days / by 6.67 equal 54.7 days in this case the lower the number the better a low number indicates that your customers are paying their bills quickly which gives you you more cash to work with inventory turnover ratio the

inventory turnover ratio provides an idea of how quickly your company turns over inventory sells it off and replaces it with new inventory during a specific period of time this number represents the ability of your firm to convert inventory Into Cash the higher the number the more often you

turnover inventory a good thing for most organizations going to Debt is a normal part of doing business Debt can plug holes when Cash Flows can’t cover all your necessary operating expenses for short periods of time Deb also allows companies

that are growing quickly to Finance their expansion however you can have too much of a good thing too much Debt for instance can be a financial drag on on

any organization Debt ratios are measures of how much Debt a company is carrying and who’s financing the Debt Debt to Equity ratio the Debt to Equity ratio measures the

extent to which a company is Financed by outside Creditors versus shareholders and owners here’s how it works Debt to

Equity ratio equals total Liabilities divided by owner’s Equity a high ratio anything more than 1.0 is considered bad because it indicates that your company may have difficulty paying back its Creditors Debt

to Assets ratio the Debt to Assets ratio measures how much of a company’s Assets are Financed by

outside Creditors versus the percentage that the owners cover in other words you divide the long-term Liabilities you have by your total Assets Debt to Assets ratio equals long-term Liabilities

divided by total Assets ratios of up to 0.50 are considered acceptable anything more may be a sign of trouble note however that most manufacturing firms have Debt to asset ratios between 0.30 and 070 Profitability ratios except for new startup

companies which aren’t expected to make money right out of the gate all companies are expected to generate Profit from their operations and as with sales and Revenue the more Profit you generate the merrier your owners and shareholders or

investors will be Profitability ratios indicate the effectiveness of management in controlling expenses and earning a reasonable return for shareholders and owners Profit ratio the Profit ratio is a measure of how much Profit your

company generates for each dollar of Revenue after you account for all costs of normal operations the inverse of this percentage 100% Profit ratio equals the expense ratio or the portion of each sales dollar that’s accounted for by expenses from normal

operations the higher the ratio the better here’s how to calculate ay comp’s Profit ratio Profit ratio equals net Income divided by net sales the expected ratio can vary considerably from industry to Industry for example although

grocery stores which make money by turning over High volumes of inventory quickly generally are satisfied with Profit ratios of just a couple percent many software developers have Profit ratios of 30 to 40% or or more gross margin the gross margin is an indication

of the Profitability of a firm to determine gross margin you use your sales Revenues and gross Profit which is what’s left over after you subtract the cost of goods sold cogs cogs the direct cost of making a product from

Revenue gross product tells you how much you have left to pay overhead costs and make a net Profit here’s how to calculate gross margin gross margin ratio equals gross Profit divided by sales Revenues return on investment

ratio return on investment better known as Roi is one of the stars of the world of financial Tools return on investment measures the ability of a company to create Profits for its owners the percentage it spits out represents the number of dollars of net Income

earned per dollar of invested Capital as such Roi is of great interest to investors shareholders and other people with a financial stake in your company these folks want to make as much money as they possibly can on their investment dollars so the higher the return on investment

the better here’s the calculation breakdown return on investment ratio equals net Income divided by owner’s Equity return on Assets ratio the return on Assets ratio also known as Roa takes the ebit earnings before

interest and Income tax that a company earns from the total Capital used to create the Profit in this sense Roa indicates the effectiveness of a company’s utilization of Capital here’s the way to calculate return on

Assets return on Assets ratio equals ebit divided by net operating Assets acceptable Roa ratios vary depending on the industry for example ratios below 5% are generally indicative of asset heavy businesses such as manufacturing and railroads while

ratios of more than 20% are indicative of asset light companies such as software and advertising firms