Financial or Ratio Analysis
Periodically financial statements are made in order to show the financial position and performance of an organization. The major financial statements include the balance sheet, income statement, statement of cash flows.These statements form the basis of financial accounting and every public company is mandated to file their financial statements and reports with the Security and Exchanges Commission (SEC). This enables all the stakeholders and the public to evaluate and understand how a given company performs in a given financial period.
Using the figures of the financial statements for given specific sections, managers and investors use ratios in measuring the performance and healthy of a given organization.
The use of ratios in financial analysis commonly known as ratio analysis is an important concept in evaluating the performance and health of a given company. Ratio analysis is commonly used to measure the solvency or profitability of a given company.
Measures of solvency or liquidity are those ratios that are focused on the availability of cash and the comparison of the available cash to other factors such as paying a company's obligations. The measures of profitability are those ratios that focus on the earnings and profits of the company.
It is important to note that comparing a given ratio between two companies from different sectors may not be fully helpful. This is because ratios differ from sector to sector or from industry to industry. Thus, when comparing ratios, it is reasonable to compare companies on the same industry.
In addition, using industry average is important to understand how a given company is performing compared to the average industry performance.
Financial ratios have been classified by the information they provide. The following are the two of the common categories of financial ratios.
Measures of liquidity
The common ratios that measures the liquidity of a company include:• Current ratio • Quick ratio
• Debt ratio • Cash ratio
• Gross Profit • Net Profit
• Operating Margin • Return on Investments (ROI)
• Return on Assets (ROA) • Return on Equity (ROE)
• Earnings per Share (EPS)• Price per earnings (P/E)
Measures of profitability
The common ratios that measures the profitability of a company include: