ratio analysis

(verb)

the use of quantitative techniques on values taken from an enterprise's financial statements

Related Terms

Examples of ratio analysis in the following topics:

  • Evaluating Financial Statements

    • With a few exceptions, the majority of the data used in ratio analysis comes from evaluation of the financial statements.
    • Ratio analysis is a tool for evaluating financial statements but also relies on the numbers in the reported financial statements being put into order to be used as ratios for comparison over time or across companies.
    • With a few exceptions, such as ratios involving stock price, the majority of the data used in ratio analysis comes from the financial statements.
    • While analysis of a company's prospects can include a number of factors, including understanding the economic situation or the industry or sentiment about the company or its products, ratio analysis of a company relies on the specific company financials.
    • Evaluating financial statements involves getting the numbers in order and then using these figures to perform ratio analysis.

  • Trend Analysis

    • Trend analysis consists of using ratios to compare company performance on an indicator over time, often to forecast or inform future events.
    • In addition to using financial ratio analysis to compare one company with others in its peer group, ratio analysis is often used to compare the company's performance on certain measures over time.
    • Fundamental analysis, on the other hand, relies not on sentiment measures (like technical analysis) but on financial statement analysis, often in the form of ratio analysis.
    • Creditors and company managers also use ratio analysis as a form of trend analysis.
    • Trend analysis using financial ratios can be complicated by the fact that companies and accounting can change over time.

  • Classification

    • Ratio analysis consists of calculating financial performance using five basic types of ratios: profitability, liquidity, activity, debt, and market.
    • Ratio analysis is one of three methods an investor can use to gain that understanding.
    • Financial statement analysis is the process of understanding the risk and profitability of a firm through analysis of reported financial information.
    • Ratio analysis is a foundation for evaluating and pricing credit risk and for doing fundamental company valuation.
    • Financial ratio analysis allows an observer to put the data provided by a company in context.

  • Limitations of Financial Statement Analysis

    • Ratio analysis using financial statements includes accounting, stock market, and management related limitations.
    • First of all, ratio analysis is hampered by potential limitations with accounting and the data in the financial statements themselves.
    • Ratio analysis using financial statements as a tool for performing stock valuation can be limited as well.
    • While the weak form of this hypothesis argues that there can be a long run benefit to information derived from fundamental analysis, stronger forms argue that fundamental analysis like ratio analysis will not allow for greater financial returns.
    • These audiences also see limits to ratio analysis as a predictor of stock market returns.

  • Benchmarking

    • Comparing the financial ratios of a company to those of the top performer in its class is a type of benchmarking.
    • Benchmarking can be done in many ways, and ratio analysis is only one of these.
    • One benefit of ratio analysis as a component of benchmarking is that many financial ratios are well-established calculations derived from verified data.
    • Benchmarking using ratio analysis can be useful to various audiences.
    • From a management perspective, benchmarking using ratio analysis may be a way for a manager to compare their company to peers using externally recognizable, quantitative data.

  • Ratio Analysis and EPS

    • Ratio analysis and EPS are used to compare the strengths and weaknesses of various companies with industry or company benchmarks.
    • Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis.
    • Times interest earned ratio (Interest Coverage Ratio): EBIT / Annual interest expense
    • Return on assets (ROA ratio or Du Pont Ratio): Net income / Average total assets
    • Ratio analysis includes profitability ratios, activity (efficiency) ratios, debt ratios, liquidity ratios and market (value) ratios

  • Balance Sheet Analysis

    • Balance sheet analysis consists of 1) reformulating reported Balance sheet, 2) analysis and adjustments of measurement errors, and 3) financial ratio analysis on the basis of reformulated and adjusted Balance sheet.
    • Financial ratio analysis should be based on regrouped and adjusted financial statements.
    • Two types of ratio analysis are performed: 3.1) Analysis of risk and 3.2) analysis of profitability:
    • Risk analysis consists of liquidity and solvency analysis.
    • A usual technique to analyze illiquidity risk is to focus on ratios such as the current ratio and interest coverage.

  • Selected Financial Ratios and Analyses

    • Financial ratios and their analysis provide information on a firm's profitability and allow comparisons between the firm and its industry.
    • Two main methods for analysis are horizontal and vertical analysis.
    • When using comparative financial statements, the calculation of dollar or percentage changes in the statement items or totals over time is horizontal analysis.
    • This analysis detects changes in a company's performance and highlights trends.
    • Vertical analysis is usually performed on a single financial statement (i.e., income statement): each item is expressed as a percentage of a significant total.

  • Interpreting Ratios and Other Sources of Company Information

    • Financial statement analysis, also known as financial analysis, is the process of understanding the risk and profitability of a company through the analysis of that company's reported financial information.
    • There are four methods for making these types of comparisons: vertical analysis, horizontal analysis, ratios, and trend percentages.
    • Ratios are expressions of logical relationships between items in financial statements from a single period.
    • It is possible to calculate a number of ratios from the same set of financial statements.
    • The only limiting factor in choosing ratios is that the items used to construct a ratio must have a logical relationship to one another.

  • Total Debt to Total Assets

    • The debt ratio is expressed as Total debt / Total assets.
    • Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis.
    • Financial ratios are categorized according to the financial aspect of the business which the ratio measures.
    • Debt ratios measure the firm's ability to repay long-term debt.
    • Like all financial ratios, a company's debt ratio should be compared with their industry average or other competing firms.