10 Financial Ratios Explained for Beginners and Practical Analysis

 

Financial ratios may appear at first to be daunting but they are simply shortcuts. Rather than reading through the financial statements, ratios can give you a quick snapshot of what's happening in a business.

You begin to see patterns; areas that are improving, areas that are diminishing, and areas that you may need to pay attention to.

Financial Ratio Analysis Basics

Financial ratio analysis is a process of making comparisons. Rs. 100 alone is not as revealing as compared to another number.

Most ratios can be categorized as profitability, efficiency, liquidity or leverage. Every one has a different perspective on performance.

Key Financial Ratios List

Certain ratios appear virtually everywhere because they're easy and handy. These are typically the first ones that analysts pay attention to and go into.

What they don't tell is everything, but a quick view is enough of a snapshot of how a business is doing.

Return on Assets Ratio (ROA)

Return on Assets (ROA) is a company's ability to make a profit from its assets.

The concept is simple – profit being generated by what the firm has. Generally, the higher the number, the more efficient the system, although this will vary from industry to industry.

Asset Turnover Ratio

Asset turnover is a measure of how well a company utilizes its assets to produce revenue.

ROA is based on profit but this ratio is based on sales. It can provide a good indication if the business is utilising its resources efficiently to generate revenue.

Profitability Ratios ROA

ROA forms part of a group of ratios that are known as profitability ratios. These ratios are designed to compare the profits that a company earns against its sales, assets or equity.

They can be helpful when assessing if a business is not only running, but generating value.

10 Financial Ratios Explained

Here are 10 Financial Ratios that are commonly used and what they show you:

• Return on Assets indicates the effectiveness of using assets to make profits.

• Return on Equity is concerned with the returns which the shareholders are getting.

• Net Profit Margin is the measure of how much profit remains after the expenses.

• Gross Profit Margin is about to look at profits after manufacturing expenses.

• Current Ratio is a measure of short term financial stability.

• Quick Ratio is the tougher of the two liquidity measures and doesn't include inventory.

• Debt to Equity Ratio measures the ratio of debt to equity.

• Interest Coverage Ratio is an indicator of the company's capacity to cover interest payments.

• The Asset Turnover Ratio is how effective a company is at turning its assets into sales.

• Inventory Turnover is a measure of how quickly inventory is turned over.

Conclusion

Financial ratios are NOT formulas to be memorized. They're all about the relationships between numbers.

After some consistent use, they come to be a speedy way to read a business. As you proceed, you will move away from the use of numbers and add more and more to your intuition gained from what you have experienced.