FREE online courses on Financial Ratio Analysis - Question 4

 

Are the owners (shareholders) receiving an adequate return on their investment?

 

We want to know if the earnings available to the firm's owners or common equity investors are attractive when compared to the returns of owners of similar companies in the same industry.

All these questions and more can be answered by using ratio analysis, which makes it one of the most powerful tools in your hand.

Don't jump to conclusions that the ratios are the ultimate tools of financial analysis and would give you straight answers regarding the financial health of the company. Almost any ratio analyzed by itself can give you misleading indications.  Consequently, when a disturbing ratio signal is encountered you should immediately seek confirmation using additional ratios or other information.  For Example, an average collection period of 60 days might be disturbing in an industry where the norm is only 30 days.  However, if the firm in question offers credit terms of 60 days with no penalty to gain market share, whereas the norm in the industry is to offer much shorter terms, this result would be expected.

 

Now we can move down to a more detail analysis with ratios. Five common groups of detail ratios are:

 

• Liquidity Ratios
• Efficiency Ratios
• Profitability Ratios
• Leverage Ratios
• Market Value Ratios