Saturday, March 31, 2012

Financial Ratios

 Financial ratios are important pointers to the performance of a company. Looking at a combination of these ration a lot of conclusion can be drawn about the company's performance and operations. The important financial ratios are as follows

Important Terms:
  1. Shareholders Equity: At any given point the equity is the total assets - total liabilities.  
  2. Operating Income: it is the income or profit generated by the operations and is calculated as total sales - COGS - operating expenses - depreciation. It is also known as EBIT earnings before interest and taxes.


Debit/Equity: This ratio is calculated as
                 Total Liabilities
             __________________
             Shareholders Equity
 a debt to equity ratio of 5 would mean that for every 1 dollar of equity there is a 5 dollar liability. Any company with a high Debt to equity would have low investor interest.



Equity Ratio: This ratio is similar to the above debt to equity ratio, however the focus here is on assets instead of the liabilities. It is used in central europe and is calculated as follows:
                     Total Equity
                  ______________
                      Total Assets
This ratio helps to detemine how much the shareholders would receive in an event of a company wide liquidation. This ratio is expressed as a percentage of the total assets. Thus an equity ratio of 45% for a company with total assets of 500 $ million would mean that in an event of liquidation all the shareholders put togeather would receive $225 million (45% * $500).



Return on Equity : This ratio is expressed as a percentage and is calculated as
                           Net Income
                 __________________
                  Shareholder's Equity
This ratio is a measure of how efficient a company is at generating profits. A company with higher ROE took lesser investment and generated higher profits and hence would be of interest to investors.


Operating Profit Margin: This ratio is expressed as a percentage and is calculated as
                      Operating Income
                    _______________
                         Total Revenue
This ratio is a measure of how much the company makes on each dollar of sales before interest and taxes. This ratio displays how efficient a companys operations are at making profits. An operating profit margin of 12% would mean that it the operations make $0.12 (before interest and taxes) for every dollar of sales.

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