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For example, suppose a company has Rs.5 million in net sales during a year and an average working capital of Rs.1 million; its working capital turnover is 5. This means the company generated Rs.5 in sales for every Rs.1 invested in working capital, indicating efficient use of working capital. Average accounts payable is the average amount owed to suppliers during the same period. For example, suppose a stock is trading at Rs.20 per Share and has a book value of Rs.10 per Share; its P/B ratio is 2 (Rs.20 per share / Rs.10 book value per Share). A P/B below 1 suggests the stock is undervalued relative to its asset value on the balance sheet. A higher P/E ratio indicates investors expect higher future growth and are willing to pay more for the stock.

Please note that costs like overheads, taxes, interests are not deducted here. Payable days have increased to 71.4 days in 2020 as compared to 68.5 days in 2017. This implies that Inventory is used up every 73 days on average and is restored to its original levels. Think of Inventory Days as the approximate number of days it takes for inventory to convert into a finished product. Days receivables or Average Receivables collection days have decreased from around 34.1 days in 2017 to 30 days in 2020. Here I have taken Colgate Case Study (2016 to 2020 financials) and calculated Ratios in excel from scratch.

Operating Efficiency Ratios

Understanding trends in key financial ratios is essential for a thorough fundamental analysis of public companies. Financial ratio analysis uses the data contained in financial documents like the balance sheet and statement of cash flows to assess a business’s financial strength. These financial ratios help business owners and average investors assess profitability, solvency, efficiency, coverage, market value, and more. Financial analysts, such as research analysts and credit rating agencies, extensively use financial ratio analysis in their reports and models. Analysts apply ratio analysis to make quantitative comparisons of financial performance between companies and across industries. Comparing profitability and efficiency ratios helps analysts identify well-managed companies.

Return on Assets

These accounting discrepancies make it difficult to compare financial ratios directly. Normalizing the ratios to account for different accounting treatments helps compensate. Average fixed assets is the average net book value of property, plant, and equipment during the period. The PEG ratio (price/earnings-to-growth ratio) compares a company’s price-to-earnings (P/E) Ratio to its expected earnings growth rate.

Horizontal analysis helps investors assess the improving or deteriorating financial strength of a company. Steady growth in revenue and profits indicates a company with competitive advantages and effective strategies. Comparing growth rates how to erase a kindle fire to industry benchmarks also provides context on performance.

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For example, suppose a company has earnings per share of Rs.2 and a dividend per share of Rs.1; its dividend cover is 2 (Rs.2 / Rs.1). This suggests the company could afford to pay its dividend twice over from earnings. A high coverage ratio provides reassurance on continued dividend payments. For example, suppose sample balance sheet template for excel Company X has a market capitalization of Rs.5 billion and its book value is Rs.2 billion, its P/BV ratio is 2.5 (Rs.5 billion / Rs.2 billion).

Days receivables are directly linked with the Accounts Receivables Turnover. Days receivables express the same information but in terms of the number of days in a year. Though some benchmarks are set externally (discussed below), ratio analysis is often not a required aspect of budgeting or planning. Technical analysis uses statistical trends gathered from trading activity, such as moving averages (MA). In investment finance, an analyst external to the company conducts an analysis for investment purposes. Analysts can either conduct a top-down or bottom-up investment approach.

1. For example, an industry facing disruption or consolidation requires a different strategy than a steadily growing industry.
2. Larger companies have other fixed charges which can be taken into account.
3. International databases like Bloomberg also cover major Indian companies and offer detailed financial analysis.
4. Bottom-up investing forces investors to consider microeconomic factors first and foremost.

The fixed charge coverage ratio is very helpful for any company that has any fixed expenses they have to pay. One fixed charge (expense) is interest payments on debt, but that is covered by the times interest earned ratio. A company’s credit rating materially impacts its cost of debt and capital structure. Comparing ratios without considering credit quality differences produces misleading results. The methods for accounting for inventory, depreciation, research & development, and other items differ between companies.

Key Takeaways

Investors and analysts can access years of income statements, balance sheets, and cash flow statements to calculate key ratios. The receivables turnover ratio measures how efficiently a company collects payment for credit sales during a period. It indicates the number of times average receivables are turned into cash.

Ratio Analysis – Categories of Financial Ratios

Vertical analysis allows investors to evaluate financial statement items independent of absolute dollar amounts, which vary widely for companies of different sizes. By standardizing to a base amount like revenue, the analysis focuses on relative proportions and trends. This reveals how well a company is managing its profitability, costs, asset efficiency, and leverage.

Analyzing past and current ratios provides a basis for making educated guesses about a company’s future prospects. For example, an increasing accounts receivable turnover ratio suggests a company expects rising sales and cash flow going forward. Ratio analysis enhances predictive ability and supplements other forecasting methods.

This suggests investors value Company X at 2.5 times its book value, which means the stock is trading at a premium. Risk-adjusted return on capital (RAROC) measures the return on capital adjusted for the riskiness of the investments. It evaluates the profitability of investments relative to the amount of risk taken. Financial ratios are only valuable if there is a basis of comparison for them. The ratios can also be compared to data from other companies in the industry.