The Financial Ratios are compared with those of the competition and lead to the analysis and reflection of the operation of the companies against their rivals. These give indicators to know if the evaluated entity is solvent, productive, if it has liquidity.
Summary
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- 1 Definition
- 2 Importance
- 3 Classification of financial ratios
- 1 Liquidity ratios
- 2 Current or circulating ratio
- 3 Quick reason
- 4 Reason for availability
- 5 Reasons for activity
- 6 Rotation of total assets
- 7 Rotation and inventory cycle
- 8 Industrial Companies
- 9 Rotation and cycle of accounts receivable
- 10 Debt reasons
- 11 Debt or debt ratio
- 12 Debt / equity ratio
- 13 Autonomy or self-financing
- 14 Profitability reasons
- 15 Gross profit margin
- 16 From operating expenses incurred
- 17 Financial Return
- 18 Profit on total assets or Economic Return
- 19 Variation in sales
- 20 Variation in Net Income
- 4 Source
Definition
- They are a photograph of the moment, avoiding the dimension in time.
- They constitute a second level of diagnosis.
- They make it possible to provide an overview of the economic-financial situation as a whole.
- They are the starting point of the analysis.
- They are consequences of policies and events and not of causes.
- The use of numerous reasons can be confusing, rather than clarifying the nature of the problem.
- They cannot be more exact than the information that your calculation allows you.
Importance
Financial ratios are of significant importance for any company, because their calculations and interpretation of the results allow the entity to know its performance, position, background and financial trends, serving as the basis for its future projection, from which it is derived the utility that it represents for the financial manager, because it allows him to know if the business is developing in a favorable or unfavorable trend and, therefore, it is necessary to have a base comparison standard, since a reason becomes significant when compared to a standard. From the foregoing, it follows that the financial indices serve as guidelines for the financial administrator, together with the management teams,
Classification of financial ratios
- Liquidity reasons.
- Activity reasons.
- Debt reasons.
- Profitability Reasons.
- Growth reasons
Liquidity ratios
Its main objective is to determine the financial conditions in which the entity is in order to face the payments that derive from its operating cycle. When applying for a loan, the company will need to demonstrate that it is in a position to face its debt, which is why credit analysts analyze various liquidity measures. The managers look at the liquid assets that are those that can be easily converted into cash at a fair market value, because they represent these more reliable figures, although they have the inconvenience that they can quickly lose validity. Liquidity is a capacity that one has to face the short-term obligations at maturity, it will be given by the liquid asset that is available, which is one that can easily be converted into cash at fair market value. Liquidity is the ability of a company to pay its short-term obligations when they are due. Liquidity is essential to run a business activity, particularly in times of adversity, such as when a business is closed due to a strike or when losses occur in operations due to an economic recession or a considerable increase in the price of a raw material. or from a piece of equipment; If liquidity is insufficient to buffer such losses, a serious financial difficulty can arise. Poor liquidity resembles a person with a fever a symptom of a fundamental problem. Liquidity is the ability of a company to pay its short-term obligations when they are due. Liquidity is essential to run a business activity, particularly in times of adversity, such as when a business is closed due to a strike or when losses occur in operations due to an economic recession or a considerable increase in the price of a raw material. or from a piece of equipment; If liquidity is insufficient to buffer such losses, a serious financial difficulty can arise. Poor liquidity resembles a person with a fever a symptom of a fundamental problem. Liquidity is the ability of a company to pay its short-term obligations when they are due. Liquidity is essential to run a business activity, particularly in times of adversity, such as when a business is closed due to a strike or when losses occur in operations due to an economic recession or a considerable increase in the price of a raw material. or from a piece of equipment; If liquidity is insufficient to buffer such losses, a serious financial difficulty can arise. Poor liquidity resembles a person with a fever a symptom of a fundamental problem. such as when a business is closed due to a strike or when losses occur in operations due to an economic recession or a considerable increase in the price of a raw material or piece of equipment; If liquidity is insufficient to buffer such losses, a serious financial difficulty can arise. Poor liquidity resembles a person with a fever a symptom of a fundamental problem. such as when a business is closed due to a strike or when losses occur in operations due to an economic recession or a considerable increase in the price of a raw material or piece of equipment; If liquidity is insufficient to buffer such losses, a serious financial difficulty can arise. Poor liquidity resembles a person with a fever a symptom of a fundamental problem.
Analyzing the liquidity of a company is especially important for creditors. If a company has a poor liquidity position, it can create credit risk, perhaps leading to an inability to make significant and periodic interest payments. Liquidity ratios are static in nature at the end of the year. Therefore, it is also important for management to examine future cash flows, if high cash disbursements are expected in the future relative to income, the company’s liquidity position will deteriorate.
Current or circulating ratio
The current ratio is equal to current assets divided by current liabilities. This relationship, which is subject to seasonal fluctuations, is used to measure the ability of a company to settle its current liabilities with current assets; requires a high reason when the firm has difficulty obtaining short-term loans. A limitation of this reason is that it can rise just before financial difficulties, due to a company’s desire to improve its cash position, for example, through the sale of fixed assets. Such provisions have a detrimental effect on productive capacity. Another limitation of the current ratio is that it will be excessively high when inventory is carried out based on the last to enter and the first to leave.
It shows the ability of the company to meet its short-term obligations with its current assets. It measures the number of times that the business’s current assets cover its short-term liabilities. For its analysis, the quality and character of current assets must be taken into account in terms of their ease of becoming effective and the maturity dates of short-term debts. This type of reason gives a rough view of the company’s ability to meet its short-term commitments. It is probably the first test developed by analysts and it is placed by them in the most important place. The analysis of this ratio shows the amount of current assets that the company has to face each peso of its short-term obligations.
- When interpreting the current ratio, it is necessary to take into account a number of factors:
- Creditors tend to believe that the higher the current ratio, the better, although from a managerial point of view there is an upper limit. A too high current ratio may indicate that capital is not being used productively in the company.
- Because creditors tend to view current ratio as an indication of short-term solvency, some companies may take deliberate steps to improve their current ratio just prior to the presentation of the financial statements at the end of the fiscal period in order to present it to bankers and other creditors. This can be accomplished by delaying credit purchases and paying current liabilities.
- The current ratio calculated at the end of the fiscal year may not represent the current position of the company throughout the year. Since many of them schedule the end of the fiscal year during a low point in the commercial season, the current ratio at the end of the year is probably more favorable than in any other period of the year.
Quick reason
The quick ratio, also known as the acid test ratio , is a rigorous liquidity test. It is found by dividing the most liquid current assets (cash, marketable securities and bills, accounts receivable) by the current liabilities. Inventory is not included because it takes more time to convert it into cash. Prepaid expenses or other payments are also not included because they are not convertible into cash and therefore cannot cover current liabilities.
It is a more rigorous test of liquidity since it indicates immediate solvency, without considering inventories, since these generally turn out to be the least liquid and constitute a strict test of the ability to pay in the short term. It is also known by the name of fast reason .
It shows the ability of the company to meet its short-term obligations with its most liquid assets, must be greater than 1. This ratio assumes the immediate conversion of the most liquid current assets into money to pay off the most pressing or urgent obligations. An index of 1 is considered acceptable, since it indicates that the necessary resources are available with a certain speed to cover each weight of the immediate debts.
Availability reason
- Cash on hand + Cash on Bank / Current liabilities
- The desirable mean value should be approximately 0.3.
- If it is less, the entity has no minimum capacity to meet its short-term obligations.
- If it is greater, the entity has the minimum capacity to assume its short-term obligations.
- The auditor should evaluate the incidence of this indicator in relation to the results reported by the Cash Flow Statement in the scope of operating activities.
Activity reasons
Activity ratios are used to determine how quickly multiple accounts convert to sales or cash. Total liquidity ratios generally do not provide an adequate picture of a company’s actual liquidity, due to differences in the classes of current assets and liabilities that the company maintains. Therefore, it is necessary to evaluate the activity or liquidity of specific current accounts. There are several reasons to measure accounts receivable, inventory, and total asset activity.
They measure the degree of effectiveness with which the company is using its resources. Rotation rates can be used to help short-term creditors estimate the time required to rotate assets such as inventories and cash receivables. This group of ratios measures the effectiveness with which assets are being managed.
Rotation of total assets
The total asset turnover ratio is useful in evaluating a company’s ability to use its asset base effectively in generating revenue. A low ratio can be due to many factors and it is important to identify the underlying reasons. For example, investment in assets is excessive when compared to the value of the items that are produced. If so, the company may wish to consolidate its current operation, perhaps by selling some of its assets and investing the product to achieve higher revenues, or use them to pursue a more profitable area.
It regulates the sales generated by each weight of assets. It determines the level of resources generated with respect to the magnitude of the resources used. It measures both the effectiveness and efficiency of the administration in its use and benefit from the available resources, as well as the sales generated by each investment weight, or the magnitude of the investment necessary to generate a certain sales volume. If turnover is low, it could indicate that the company is not generating enough sales volume in proportion to its investment.
Rotation and inventory cycle
If a company maintains an excess inventory, it means that it has restricted inventory funds that could be used elsewhere. In addition, there would be high handling costs for the storage of goods, as well as for the risk that they would fall into disuse. On the other hand, if the inventory is too low, the company can lose customers because it runs out of merchandise. The two most important reasons for evaluating inventory are: inventory turnover and average age of inventory.
Measure inventory renewal, the more inventory accounts rotate the more liquidity they have, that is, the faster they become cash. The use of this ratio helps to detect problems of accumulation or shortage of merchandise, obsolete inventories, price problems, deficiencies in the commercial area, etc. The cost of goods sold figure in the income statement represents the total cost of all goods that have been transferred from inventory during a given period. Therefore, the relationship between the cost of goods sold and the average balance of inventories held during the year indicates the number of times inventories that have been replaced throughout the year rotate. Determines the number of times stocks rotate in the year and is also known as the inventory turnover cycle. Its importance is that if it reflects that an entity maintains an excess of inventories it means that it has restricted funds in inventories that could be used elsewhere. In addition, there would be a high cost of handling for the storage of goods as well as the risk that they would fall into disuse. On the other hand, if the inventory is too low, the entity could lose customers because it runs out of merchandise. In addition, there would be a high cost of handling for the storage of goods as well as the risk that they would fall into disuse. On the other hand, if the inventory is too low, the entity could lose customers because it runs out of merchandise. In addition, there would be a high cost of handling for the storage of goods as well as the risk that they would fall into disuse. On the other hand, if the inventory is too low, the entity could lose customers because it runs out of merchandise.
The ideal would be to be able to add the inventories at the end of each month and divide by 12 to obtain an average inventory, however this information is not available, the closest substitute is to obtain a simple average by adding the inventory figures at the beginning and at the end of the year.
The result gives the number of days that the goods are renewed in a given period of time. The comparison provides a valuable indication of efficiency and inventory control. A relatively slow replenishment means overinvestment in commodities, a relatively quick replacement contributes considerably to a capital replacement. For any business there is a normal period in which inventories must be sold or converted into cash or accounts receivable; Taking the goods beyond this period means that extra-financial pesos are incurred in fixed and administrative costs, all of which must be paid with the sales margin.
In the event that cost of sales is not available, sales are used as a substitute, although this would no longer be an appropriate definition, especially in high-margin businesses, since sales contain a profit margin that is not included. in inventories. Occasionally, inventory is designated at the end of the year instead of its average. In any case, whatever definition you use, it must be invariable for its comparisons to be meaningful.
When you are in the presence of an industrial company to the Inventory of finished goods. It may be valuable to calculate in some companies a Raw Materials Inventory Rotation and it would be defined as the purchases of Raw Materials divided by the average of the Raw Materials inventory of the period and would indicate how many times the inventory of raw materials is acquired during the period.
