Docy Child

Ratio analysis lets you look more closely at the information in the three financial statements.

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Financial statements tell you a lot about a company, like how much money it made, where it spent its money, and how much it owes. But how do you figure out what all of these numbers mean? For example, how much money does the company make? Is the amount of debt good or bad? With ratio analysis, you can get a deeper look at the information in the three financial statements.

Using ratios, you can compare how well your company is doing to the averages for its industry and to how well it did in the past.

Ratios of Profitability

These numbers show how profitable a company is by putting its profits as a percentage of other numbers.

Earnings from assets (ROA). ROA shows how well a company is making money by using its assets. It's a good way to compare the size of different companies.

Return on investment (ROE). ROE shows the profit as a percentage of the stockholders' equity. In a sense, it is the owners' return on their investment, and you can bet that shareholders will compare it to what they could earn with other investments.

Return on sales (ROS). ROS, which is also called net profit margin, shows how well a company controls its costs and turns its income into bottom-line profit.

Gross margin of profit. Taking only direct costs into account, the gross profit margin shows how well a company makes its goods or provides its services.

Profitability ratios will tell you if your company's profits are strong or weak.

Operating Ratio

This shows how well a company is putting its assets to work and handling its cash.

Asset turnover. This ratio shows how well a company makes money with all of its assets, like cash, equipment, and so on. It gives the answer to the question, "How much money do we make for each dollar of assets?"

Receivable days. This number, which is also called days sales outstanding (DSO), shows how quickly a business gets the money it is owed by customers.

Days payable. This number, which is also known as days payable outstanding (DPO), shows how fast a company pays its suppliers. If everything else stays the same, the longer it takes, the more cash a company has to work with.

Operating ratios help you figure out how efficient a company is.

Liquidity Ratios

Liquidity ratios show how well a company can meet its short-term financial obligations, like paying off debt, making payroll, and paying its bills.

Ratio right now. This ratio compares the current assets and current liabilities of a company. To figure it out, divide the total amount of current assets by the total amount of current debts.

Short answer. This ratio isn't easier to figure out than any other, but it does show how quickly a company can meet its current obligations.

Debt Ratio

Coverage of interest. This ratio measures how safe a company's debt is, or how much profit it makes compared to how much it pays in interest over a certain time period.

From debt to stock. This measure shows how much a company borrows money to improve its return on owners' equity.

When you compare a company's ratios to those of its competitors and to the averages for its industry, you can often see what its financial strengths and weaknesses are. For example, if your company's debt-to-equity ratio is higher than average, it may be more likely to be hurt by a downturn in the industry.

Have you heard? You can tell if a company will be able to pay its bills by looking at its current and quick ratios. If it can't do that easily, it may cut costs quickly. It might even need to change how it runs.

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