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Among the tools used to assess an organization’s financial health is Ratio Analysis. Comparing multiple relevant accounting statistics is all that constitutes ratio analysis, also known as accounting ratios. It is not easy to gauge the health of a company only based on its financial records. When ratio analysis tools are used, it will be possible to determine how the company is doing. Ratio analysis is used to conduct a comprehensive quantitative study of financial data.
When performing ratio analysis, you’re determining a company’s overall financial health. Many financial ratios exist; however, the following are the most crucial:
- Current Ratio: One of the most essential and well-known ratios is the current one. It is used to determine the company’s present or working capital. The idea is to see if its existing assets can pay off its current or short-term debts.
Formula: Current Assets divided by Current Liabilities is the formula for the Current Ratio
- Quick Ratio: Acid-test or Quick Ratio for a company’s liquidity that can be gauged by looking at its debt-to-equity Ratio. Inventory and Current Liabilities provide the information needed to make this determination.
- Cash Flow Ratio: An organization’s current liabilities, such as shares and bills receivable, can be determined by calculating the “cash ratio.”
Indicator of Profitability Ratios
- Detailed Profit Margin Calculation: It is a thorough examination of the company’s earnings from sales. This Ratio can be used to calculate the profit/sales or per capita revenue generated by each sale.
Gross Profit Margin (Gross Profit / Net Sales) is also included (Revenue)
To calculate operating profit, divide net sales by operating profit (Revenue)
Net Profit Margin Equals Net Sales Margin (Revenue)
- Based on its total assets, how profitable the company is is determined by the Ratio. Return on Assets (ROA) is calculated as follows: net income / total asset average.
Return on Equity
The Ratio is essential in determining net income and comparing it to the equity of the shareholders.
Debt-to-Equity
The Debt Ratio measures the company’s financial leverage by comparing its total debt to its total assets. Total liabilities divided by total assets is known as the debt ratio.
- Debt-to-Equity Ratio: Like the previous Ratio, debt-equity analyses the company’s situation in terms of obligations to its capital.
- The ratio of Cash Flow to Debt: When comparing total debt to operating cash flow, this Ratio is calculated. There is a formula for this Income from operating activities divided by total debt
- Operational Performance Ratios: An organization’s productivity can be gauged by looking at these ratios. Its utilization of resources can judge a company’s efficiency and effectiveness.
- Fixed-Assets Return on Investment: As an approximate indicator of a company’s fixed assets about its revenues, this Ratio is calculated. Property, Plant, and Equipment (PP&E) / Revenue
- Per-Employee Revenue: It’s a measure of the efficiency of the workforce. This ratio measures the number of currency sales or revenue made by each employee. The number of employees divided by Income is the formula (Avg.)
Ratios of Cash Flow
- As a measure of operating cash flow/sales: The operating cash flow to revenue ratio measures the company’s ability to pay its bills. It would be alarming if its sales increased, but its cash flow didn’t follow suit. Cash flow from operations divided by net sales (revenue)
- Free cash flow/operating cash flow: Operating cash flow minus capital expenditure is the definition of free cash flow. There is a formula for this Operating Cash Flow/Free Cash Flow (cash flow from operations minus capital expenditures).
- Payout ratio of dividends: This Ratio is used to determine how much of a company’s earnings per equity share is earmarked for dividends. It’s a measure of how effectively the company’s profits can support its dividends. Dividend per ordinary share/Earnings per share is the formula for calculating the dividend.
Relative Strength to Weakness of an Investment
- Pricing/Book Value Ratio: To calculate this ratio, you divide the stock price by the stock’s book value. It shows how much shareholders are willing to pay for the company’s net assets. Balance sheet assets are used to calculate a company’s book value. In a balance sheet, it is the difference between assets and liabilities. Equivalent stock/equity per share is the formula to use.
- Price-to-cash-flow: The stock’s market price is compared to the per-share cash flow generated by the company to arrive at this Ratio. To calculate the stock price per share, divide operating cash flow per share by the stock price per share.
- A company’s P/E Ratio: For each dollar of Earnings Per Share, the price of the stock is multiplied by the Ratio. Earnings Per Share / Stock Price Per Share (EPS)
- Price-to-Sales Ratio: Instead of earnings, the stock price-to-sales Ratio looks at how much a company is worth. Per-share, the calculation is Stock Price / Net Sales (Revenue).
- Dividend Yield Ratio: The formula for calculating the dividend is the yearly dividend per share divided by the stock price per share.
- Enterprise Value Multiple: It is calculated by dividing the company’s enterprise value by its pre-tax earnings before interest and taxes. The calculation is EBITDA divided by Enterprise Value.
Among the tools used to assess an organization’s financial health is Ratio Analysis. Comparing multiple relevant accounting statistics is all that constitutes ratio analysis, also known as accounting ratios. It is not easy to gauge the health of a company only based on its financial records. When ratio analysis tools are used, it will be possible to determine how the company is doing. Ratio analysis is used to conduct a comprehensive quantitative study of financial data.
Conclusion
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