In addition to the 10K, companies have to file 10Qs every three months, which give their quarterly financial performance. Profitability ratios show how much profit the company takes in for every dollar of sales or revenues. Profitability ratios are going to vary from industry to industry, so comparisons should be between other companies in the same field. When comparing companies in the same industry, the company with the higher profit margin is able to sell at a higher price or lower expenses.
They tend to be more attractive to investors. Many analysts focus on net profit margins or returns on sales, which are calculated by taking the net income after taxes and dividing by the revenues or sales.
This ratio uses the bottom line on the income statement to calculate profit for every dollar of sales or revenues. The operating margin takes the profit before taxes further up the income statement and divides by revenues. Operating margins are also important, since they focus on the operating income and operating expenses. Other profitability ratios include:. A high liquidity ratio indicates that a business is holding too much cash that could be utilized in other areas.
A low liquidity ratio means a firm may struggle to pay short-term obligations. Acceptable current ratios vary from industry to industry. For a healthy business, a current ratio will generally fall between 1. If current liabilities exceed current assets i. If the current ratio is too high, the company may be inefficiently using its current assets or its short-term financing facilities. This may also indicate problems in working capital management. The acid test ratio or quick ratio is similar to current ratio except in that it ignores inventories.
It is equal to:. Typically the quick ratio is more meaningful than the current ratio because inventory cannot always be relied upon to convert to cash. A ratio of is recommended. Low values for the current or quick ratios values less than 1 indicate that a firm may have difficulty meeting current obligations. Low values, however, do not indicate a critical problem. If an organization has good long-term prospects, it may be able to borrow against those prospects to meet current obligations.
A firm may improve its liquidity ratios by raising the value of its current assets, reducing the value of current liabilities, or negotiating delayed or lower payments to creditors. The debt service coverage ratio DSCR , also known as debt coverage ratio DCR , is the ratio of cash available for debt servicing to interest, principal, and lease payments.
The higher this ratio is, the easier it is to obtain a loan. In general, it is calculated as:. A similar debt utilization ratio is the times interest earned TIE , or interest coverage ratio.
Leverage Ratios : Leverage ratios for some investment banks. Most financial ratios have no universal benchmarks, so meaningful analysis involves comparisons with competitors and industry averages.
These statements include the income statement, balance sheet, statement of cash flows, and a statement of retained earnings. Financial statement analysis is a method or process involving specific techniques for evaluating risks, performance, financial health, and future prospects of an organization.
Financial statements can reveal much more information when comparisons are made with previous statements, rather than when considered individually. Horizontal analysis compares financial data, such as an income statements, over a period of several quarters or years. When comparing past and present financial information, one will want to look for variations such as higher or lower earnings.
Moreover, it is often useful to compare the financial statements of companies in related industries. Ratios of risk such as the current ratio, the interest coverage, and the equity percentage have no theoretical benchmarks. Generally weighted average Outstanding shares are used since outstanding shares can change over time. Sometime Diluted EPS are used which includes options, convertible securities and warrants outstanding which affects outstanding shares.
Business with high debt Equity ratio indicates that it is more dependent on debts for operation. Total Debt includes both long term and short term debts held by the company. Debt to Asset ratio can be used to determine if the business will be able to pay all of its debts if the business is closed immediately. It includes all the debt and assets of the company but there are different variations of this formula where only certain assets or specific liabilities are included. A company having a debt to asset ratio of less than 1 is considered as good for investment.
If the ratio is greater than 1, the company is considered as highly leveraged. The liabilities to assets ratio is also known as solvency ratio indicates how much of a company's assets are made of liabilities.
Total long-term debt and total assets tangible and intangible are reported on the balance sheet are considered. A high liability to assets ratio indicates the business might face potential solvency issues. Net Income before deducting interest and taxes by the company's interest expense and taxes are considered as a percentage on interest expense. Receivables Turnover ratio measures how soon the firms collect its receivables.
For the ratio calculation, monthly average receivables and sales on credit terms are used generally. A high receivable ratio indicates that the business sales collection process is working well. It is generally measured using inventory period which is the average inventory divided by average cost of goods is sold.
Strong gross profitability combined with weak net profitability may indicate a problem with indirect operating expenses or non-operating items, such as interest expense. In general terms, net profitability shows the effectiveness of management. Though the optimal level depends on the type of business, the ratios can be compared for firms in the same industry.
A very low return on asset, or ROA, usually indicates inefficient management, whereas a high ROA means efficient management.
However, this ratio can be distorted by depreciation or any unusual expenses. Due to leverage, this measure will generally be higher than return on assets. ROI is considered to be one of the best indicators of profitability.
It is also a good figure to compare against competitors or an industry average. Experts suggest that companies usually need at least percent ROI in order to fund future growth. If this ratio is too low, it can indicate poor management performance or a highly conservative business approach. On the other hand, a high ROI can mean that management is doing a good job, or that the firm is undercapitalized.
It can be helpful in further comparison to the market price of the stock. Although the ideal level for this ratio varies greatly, a very low figure may mean that the company maintains too many assets or has not deployed its assets well, whereas a high figure means that the assets have been used to produce good sales numbers. This ratio will vary widely from one industry to another.
A high figure relative to one's industry average can indicate either good personnel management or good equipment. Liquidity ratios demonstrate a company's ability to pay its current obligations. In other words, they relate to the availability of cash and other assets to cover accounts payable, short-term debt, and other liabilities. All small businesses require a certain degree of liquidity in order to pay their bills on time, though start-up and very young companies are often not very liquid.
In mature companies, low levels of liquidity can indicate poor management or a need for additional capital. Any company's liquidity may vary due to seasonality, the timing of sales, and the state of the economy. But liquidity ratios can provide small business owners with useful limits to help them regulate borrowing and spending. Some of the best-known measures of a company's liquidity include:. Though the ideal current ratio depends to some extent on the type of business, a general rule of thumb is that it should be at least A lower current ratio means that the company may not be able to pay its bills on time, while a higher ratio means that the company has money in cash or safe investments that could be put to better use in the business.
Ideally, this ratio should be If it is higher, the company may keep too much cash on hand or have a poor collection program for accounts receivable. If it is lower, it may indicate that the company relies too heavily on inventory to meet its obligations.
Let's look at a few simple examples. Net profit margin , often referred to simply as profit margin or the bottom line, is a ratio that investors use to compare the profitability of companies within the same sector.
It's calculated by dividing a company's net income by its revenues. Instead of dissecting financial statements to compare how profitable companies are, an investor can use this ratio instead. Ratios are typically only comparable across companies within the same sector. For example, a debt-equity ratio that might be normal for a utility company might be deemed unsustainably high for a technology play.
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