Financial Analysis

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Ratio analysis

Encyclopedia of Management
Encyclopedia of Small Business
Further reading

Financial Ratios
Encyclopedia of Management | 2009 | Copyright

Financial Ratios
USE AND USERS OF RATIO ANALYSIS
PROFITABILITY RATIOS
ASSET UTILIZATION RATIOS
LEVERAGE RATIOS
LIQUIDITY RATIOS
MARKET VALUE RATIOS
COMMON SIZE RATIOS
CAUTIONS ON THE USE AND INTERPRETATION OF FINANCIAL RATIOS
BIBLIOGRAPHY

Financial ratios are one of the most common tools of managerial decision making. A ratio is the comparison of one number to another—mathematically, a simple division problem. Financial ratios involve the comparison of various figures from financial statements in order to gain information about a company's performance. It is the interpretation, rather than the calculation, that makes financial ratios a useful tool for business managers. Ratios may serve as indicators, clues, or red flags regarding noteworthy relationships between variables used to measure the firm's performance in terms of profitability, asset utilization, liquidity, leverage, or market valuation.

USE AND USERS OF RATIO ANALYSIS
There are basically two uses of financial ratio analysis: to track individual firm performance over time, and to make comparative judgments regarding firm performance. Firm performance is evaluated using trend analysis—calculating individual ratios on a per-period basis, and tracking their values over time. This analysis can be used to spot trends that may be cause for concern, such as an increasing average collection period for outstanding receivables or a decline in the firm's liquidity status. In this role, ratios serve as red flags for troublesome issues, or as benchmarks for performance measurement.

Another common usage of ratios is to make relative performance comparisons. For example, comparing a firm's profitability to that of a major competitor or observing how the firm... [continues]

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