Tricks for a Successful Ratio Analysis in Finance Assignment

Ratio analysis can be defined as a quantitative analysis of data obtained from the financial statements of a company. It assists in evaluating financial and operating performance, particularly in the context of efficiency, solvency, liquidity and profitability. It also provides a brief idea regarding the financial health of the company by comparing its performance over time. This, in turn, helps in assessing whether the company is improving or not.

Never the less, the ratios can be categorized into six groups: liquidity ratios measuring the capability of the company in clearing off its short term debt obligations, then solvency ratios, comparing the company’s total amount of debts with its assets. Next profitability ratios which provide a clear and comprehensible picture regarding the generation of profits from the operations of the company. Also, efficiency ratios evaluate the proper usage of assets and liabilities of the company, while coverage ratios measure the ability of the company to pay its obligations and the interest payments. And finally, the market prospect ratios which determine the trend of stocks and calculate the earnings from the investments.

To carry on the ratio analysis successfully, the financial statements of the company need to be studied thoroughly. In the case of liquidity ratios, the current ratio needs to be calculated from the balance sheet. To do this, current assets need to be divided by current liabilities, where both these elements can be found from the highlighted numbers. Similarly, the quick ratio and the net working capital can also be calculated using simple formulas. For instance, in case of quick ratio, the total inventory needs to be deducted from the current assets and then on dividing the resulting value by current liabilities will give the value for quick ratio. The networking capital can also be calculated by deducting the current liabilities from the current assets.

So, using simple formulas liquidity position of the company can be known. In case of profitability ratios also, gross margin can be calculated very easily. That is to say only by dividing gross profit by net sales and multiplying the quotient with 100 would provide the amount of cost that has spent to produce the company’s product. In a similar way, operating margin, return on assets and return on equity can also be calculated very easily by only applying the formulas. It is better to use simple ratios than the complex ones to prevent incorrect results. Thus, the only trick that can be used while analyzing ratios is to use simple formulae, which will provide appropriate outcomes.