Notes of Financial Ratios
Autor: yoedyo • January 3, 2016 • Course Note • 782 Words (4 Pages) • 888 Views
• Financial Ratios
o Definition: A number from a financial statement that has been divided by another number. “A financial number presented as a reference with respect to another”
o Choice of scale is crucial
The denominator of a financial ratio must be relevant and provide the right feedback to the analyst
• Return on Equity- ROE
o ROE= net income/ stockholders equity
o How much equity has been invested in the company to generate income
• Short Term Liquidity Ratios
o Liquid Assets
Have secondary markets and can be sold for cash with minimal loss
• An asset is more liquid when it can be sold with minimal loss
o As we examine a company’s liquidity position we are trying to understand whether the firm can pay its bills if cash from operations is insufficient to pay short term obligations. Can a company turn current assets into cash quickly without a loss of value
o Insolvency: inability to pay debts when they are due
Therefore short term liquidity ratios are also known as short term solvency ratios
o 2 most important short term liquidity ratios: Current Ratio and Quick Ratio
• Current Ratio
o The ratio of current assets to current liabilities
o How well is a company’s current assets performing compared to its current liabilities
o Current Ratio = Current Assets / Current Liabilities
o In general Current Ratio must be greater than one.
o The higher the current ratio of a company the more liquid it is
o What does it mean?
To Creditors: it means that companies with high current ratio have the ability to make payments to loans/debts
To Stockholders: High liquidity is not a good sign. High liquidity mean that a company has too much money tied up in current assets and leaving less cash flow for investors
• Quick Ratio/ Acid-Test Ratio
o Similar to current ratio but inventory is subtracted from current assets in the calculation
o This calculation exist due to the fact that inventory is generally not as liquid as other assets
Inventory can generally be sold for cash but with a loss
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