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Financial Ratio Analysis Tutorial With Examples

The Balance Sheet for Financial Ratio Analysis

The income statement for financial ratio analysis, analyzing the liquidity ratios, the current ratio, the quick ratio, analyzing the asset management ratios accounts receivable, receivables turnover, average collection period, inventory, fixed assets, total assets, inventory turnover ratio, fixed asset turnover, total asset turnover, analyzing the debt management ratios, debt-to-asset ratio, times interest earned ratio, fixed charge coverage, analyzing the profitability ratios, net profit margin, return on assets, return on equity, financial ratio analysis of xyz corporation.

While it may be more fun to work on marketing efforts, the financial management of a firm is a crucial aspect of owning a business. Financial ratios help break down complex financial information into key details and relationships. Financial ratio analysis involves studying these ratios to learn about the company's financial health.

Here are a few of the most important financial ratios for business owners to learn, what they tell you about the company's financial statements, and how to use them.

Key Takeaways

• Some of the most important financial ratios for business owners include the current ratio, the inventory turnover ratio, and the debt-to-asset ratio.
• These financial ratios quickly break down the complex information from financial statements .
• Financial ratios are snapshots, so it's important to compare the information to previous periods of data as well as competitors in the industry.

Here is the balance sheet we are going to use for our financial ratio tutorial. You will notice there are two years of data for this company so we can do a time-series (or trend) analysis and see how the firm is doing across time.

Here is the complete income statement for the firm for which we are doing financial ratio analysis. We are doing two years of financial ratio analysis for the firm so we can compare them.

Refer back to the income statement and balance sheet as you work through the tutorial.

The first ratios to use to start getting a financial picture of your firm measure your liquidity, or your ability to convert your current assets to cash quickly. They are two of the 13 ratios. Let's look at the current ratio and the quick (acid-test) ratio .

The current ratio measures how many times you can cover your current liabilities. The quick ratio measures how many times you can cover your current liabilities without selling any inventory and so is a more stringent measure of liquidity.

Remember that we are doing a time series analysis, so we will be calculating the ratios for each year.

Current Ratio : For 2022, take the Total Current Assets and divide them by the Total Current Liabilities. You will have: Current Ratio = 642/543 = 1.18X. This means that the company can pay for its current liabilities 1.18 times over. Practice calculating the current ratio for 2023.

Your answer for 2023 should be 1.31X. A quick analysis of the current ratio will tell you that the company's liquidity has gotten just a little bit better between 2022 and 2023 since it rose from 1.18X to 1.31X.

Quick Ratio : In order to calculate the quick ratio, take the Total Current Ratio for 2022 and subtract out Inventory. Divide the result by Total Current Liabilities. You will have: Quick Ratio = (642-393)/543 = 0.46X. For 2023, the answer is 0.52X.

Like the current ratio, the quick ratio is rising and is a little better in 2023 than in 2022. The firm's liquidity is getting a little better. The problem for this company, however, is that they have to sell inventory to pay their short-term liabilities and that is not a good position for any firm to be in. This is true in both 2022 and 2023.

This firm has two sources of current liabilities: accounts payable and notes payable. They have bills that they owe to their suppliers (accounts payable) plus they apparently have a bank loan or a loan from some alternative source of financing. We don't know how often they have to make a payment on the note.

Asset management ratios are the next group of financial ratios that should be analyzed. They tell the business owner how efficiently they employ their assets to generate sales. Assume all sales are on credit.

• Receivables Turnover = Credit Sales/Accounts Receivable
• Receivables Turnover = 2,311/165 = 14X

A receivables turnover of 14X in 2022 means that all accounts receivable are cleaned up (paid off) 14 times during the 2022 year. For 2023, the receivables turnover is 15.28X. Look at 2022 and 2023 Sales in The Income Statement and Accounts Receivable in The Balance Sheet.

The receivables turnover is rising from 2022 to 2023. We can't tell if this is good or bad. We would really need to know what type of industry this firm is in and get some industry data to compare to.

Customers paying off receivables is, of course, good. But, if the receivables turnover is way above the industry's, then the firm's credit policy may be too restrictive.

The average collection period is also about accounts receivable. It is the number of days, on average, that it takes a firm's customers to pay their credit accounts. Together with receivables turnover, the average collection helps the firm develop its credit and collections policy.

• Average Collection Period = Accounts Receivable/Average Daily Credit Sales
• To arrive at average daily credit sales, take credit sales and divide by 360
• Average Collection Period = $165/2,311/360 = $165/6.42 = 25.7 days
• In 2023, the average collection period is 23.5 days

From 2022 to 2023, the average collection period is dropping. In other words, customers are paying their bills more quickly. Compare that to the receivables turnover ratio. Receivables turnover is rising and the average collection period is falling.

This makes sense because customers are paying their bills faster. The company needs to compare these two ratios to industry averages. In addition, the company should take a look at its credit and collections policies to be sure they are not too restrictive. Take a look at the image above and you can see where the numbers came from on the balance sheets and income statements.

Along with the accounts receivable ratios that we analyzed above, we also have to analyze how efficiently we generate sales with our other assets: inventory, plant and equipment, and our total asset base.

The inventory turnover ratio is one of the most important ratios a business owner can calculate and analyze. If your business sells products as opposed to services, then inventory is an important part of your equation for success.

Inventory Turnover = Sales/Inventory

If your inventory turnover is rising, that means you are selling your products faster. If it is falling, you are in danger of holding obsolete inventory. A business owner has to find the optimal inventory turnover ratio where the ratio is not too high and there are no stockouts or too low where there is obsolete money. Both are costly to the firm.

For this company, their inventory turnover ratio for 2022 is:

Inventory Turnover Ratio = Sales/Inventory = 2,311/393 = 5.9X

This means that this company completely sells and replaces its inventory 5.9 times every year. In 2023, the inventory turnover ratio is 6.8X. The firm's inventory turnover is rising. This is good in that they are selling more products. The business owner should compare the inventory turnover with the inventory turnover ratio of other firms in the same industry.

The fixed asset turnover ratio analyzes how well a business uses its plant and equipment to generate sales. A business firm does not want to have either too little or too much plant and equipment. For this firm for 2022:

Fixed Asset Turnover = Sales/Fixed Assets = 2,311/2,731 = 0.85X

For 2023, the fixed asset turnover is 1.00. The fixed asset turnover ratio is dragging down this company. They are not using their plant and equipment efficiently to generate sales as, in both years, fixed asset turnover is very low.

The total asset turnover ratio sums up all the other asset management ratios. If there are problems with any of the other total assets, it will show up here, in the total asset turnover ratio.

Total Asset Turnover = Sales/Total Asset Turnover = Sales/Total Assets = 2,311/3,373 = 0.69X for 2022. For 2023, the total asset turnover is 0.80. The total asset turnover ratio is somewhat concerning since it was not even 1X for either year.

This means that it was not very efficient. In other words, the total asset base was not very efficient in generating sales for this firm in 2022 or 2023. Why?

It seems that most of the problem lies in the firm's fixed assets. They have too much plant and equipment for their level of sales. They either need to find a way to increase their sales or sell off some of their plant and equipment. The fixed asset turnover ratio is dragging down the total asset turnover ratio and the firm's asset management in general.

There are three debt management ratios that help a business owner evaluate the company in light of its asset base and earning power. Those ratios are the debt-to-asset ratio, the times interest earned ratio , and the fixed charge coverage ratios. Other debt management ratios exist, but these help give business owners the first look at the debt position of the company and the prudence of that debt position.

The first debt ratio that is important for the business owner to understand is the debt-to-asset ratio ; in other words, how much of the total asset base of the firm is financed using debt financing. For example. the debt-to-asset ratio for 2022 is:

Total Liabilities/Total Assets = $1,074/3,373 = 31.8%. This means that 31.8% of the firm's assets are financed with debt. In 2023, the debt ratio is 27.8%. In 2023, the business is using more equity financing than debt financing to operate the company.

We don't know if this is good or bad since we do not know the debt-to-asset ratio for firms in this company's industry. However, we do know that the company has a problem with its fixed asset ratio which may be affecting the debt-to-asset ratio.

The times interest earned ratio tells a company how many times over a firm can pay the interest that it owes. Usually, the more times a firm can pay its interest expense the better. The times interest earned ratio for this firm for 2022 is:

• Times Interest Earned = Earnings Before Interest and Taxes/Interest = 276/141 = 1.96X
• For 2023, the times interest earned ratio is 3.35

The times interest earned ratio is very low in 2022 but better in 2023. This is because the debt-to-asset ratio dropped in 2023.

The fixed charge coverage ratio is very helpful for any company that has any fixed expenses they have to pay. One fixed charge (expense) is interest payments on debt, but that is covered by the times interest earned ratio.

Another fixed charge would be lease payments if the company leases any equipment, a building, land, or anything of that nature. Larger companies have other fixed charges which can be taken into account.

• Fixed charge coverage = Earnings Before Fixed Charges and Taxes/Fixed Charges

In both 2022 and 2023 for the company in our example, its only fixed charge is interest payments. So, the fixed charge coverage ratio and the times interest earned ratio would be exactly the same for each year for each ratio.

The last group of financial ratios that business owners usually tackle are the profitability ratios as they are the summary ratios of the 13 ratio group. They tell the business firm how they are doing on cost control, efficient use of assets, and debt management, which are three crucial areas of the business.

The net profit margin measures how much each dollar of sales contributes to profit and how much is used to pay expenses. For example, if a company has a net profit margin of 5%, this means that 5 cents of every sales dollar it takes in goes to profit and 95 cents goes to expenses. For 2022, here is XYZ, Inc.'s net profit margin:

Net Profit Margin = Net Income/Sales Revenue = 89.1/2,311 = 3.9%

For 2023, the net profit margin is 6.5%, so there was quite an increase in their net profit margin. You can see that their sales took quite a jump but their cost of goods sold rose. It is the best of both worlds when sales rise and costs fall. Bear in mind: The company can still have problems even if this is the case.

The return on assets ratio, also called return on investment , relates to the firm's asset base and what kind of return they are getting on their investment in their assets. Look at the total asset turnover ratio and the return on asset ratio together. If total asset turnover is low, the return on assets is going to be low because the company is not efficiently using its assets.

Another way to look at the return on assets is in the context of the Dupont method of financial analysis. This method of analysis shows you how to look at the return on assets in the context of both the net profit margin and the total asset turnover ratio.

• To calculate the Return on Assets ratio for XYZ, Inc. for 2022, here's the formula:
• Return on Assets = Net Income/Total Assets = 2.6%

For 2023, the ROA is 5.2%. The increased return on assets in 2023 reflects the increased sales and much higher net income for that year.

The return on equity ratio is the one of most interest to the shareholders or investors in the firm. This ratio tells the business owner and the investors how much income per dollar of their investment the business is earning. This ratio can also be analyzed by using the Dupont method of financial ratio analysis. The company's return on equity for 2022 was:

Return on Equity = Net Income/Shareholder's Equity = 3.9%

For 2023, the return on equity was 7.2%. One reason for the increased return on equity was the increase in net income. When analyzing the return on equity ratio, the business owner also has to take into consideration how much of the firm is financed using debt and how much of the firm is financed using equity.

Now we have a summary of all 13 financial ratios for XYZ Corporation. The first thing that jumps out is the low liquidity of the company. We can look at the current and quick ratios for 2022 and 2023 and see that the liquidity is slightly increasing between 2022 and 2023, but it is still very low.

By looking at the quick ratio for both years, we can see that this company has to sell inventory in order to pay off short-term debt. The company does have short-term debt: accounts payable and notes payable, and we don't know when the notes payable will come due.

Let's move on to the asset management ratios. We can see that the firm's credit and collections policies might be a little restrictive by looking at the high receivable turnover and low average collection period. Customers must pay this company rapidly—perhaps too rapidly. There is nothing particularly remarkable about the inventory turnover ratio, but the fixed asset turnover ratio is remarkable.

The fixed asset turnover ratio measures the company's ability to generate sales from its fixed assets or plant and equipment. This ratio is very low for both 2022 and 2023. This means that XYZ has a lot of plant and equipment that is unproductive.

It is not being used efficiently to generate sales for the company. In addition, the company has to service the plant and equipment, pay for breakdowns, and perhaps pay interest on loans to buy it through long-term debt.

It seems that a very low fixed asset turnover ratio might be a major source of problems for XYZ. The company should sell some of this unproductive plant and equipment, keeping only what is absolutely necessary to produce their product.

The low fixed asset turnover ratio is dragging down total asset turnover. If you follow this analysis through, you will see that it is also substantially lowering this firm's return on assets profitability ratio.

With this firm, it is hard to analyze the company's debt management ratios without industry data. We don't know if XYZ is a manufacturing firm or a different type of firm.

As a result, analyzing the debt-to-asset ratio is difficult. What we can see, however, is that the company is financed more with shareholder funds (equity) than it is with debt as the debt-to-asset ratio for both years is under 50% and dropping.

This fact means that the return on equity profitability ratio will be lower than if the firm was financed more with debt than with equity. On the other hand, the risk of bankruptcy will also be lower.

Unfortunately, you can see from the times interest earned ratio that the company does not have enough liquidity to be comfortable servicing its debt. The company's costs are high and liquidity is low. Fortunately, the company's net profit margin is increasing because their sales are increasing.

Hopefully, this is a trend that will continue. Return on Assets is impacted negatively due to the low fixed asset turnover ratio and, to some extent, by the receivables ratios. Return on equity is increasing from 2022 to 2023, which will make investors happy.

As you can see, it is possible to do a cursory financial ratio analysis of a business firm with only 13 financial ratios, even though ratio analysis has inherent limitations.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.2 Operating Efficiency Ratios ." OpenStax.

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 2, 4.

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 3, 6.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.4 Solvency Ratios ." OpenStax.

Nasdaq. " Fixed-Charge Coverage Ratio ."

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 3, 5.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.6 Profitability Ratios and the DuPont Method ." OpenStax.

Financial Ratio Analysis

Home › Finance › Financial Ratio Analysis › Financial Ratio Analysis

Financial ratios are mathematical comparisons of financial statement accounts or categories. These relationships between the financial statement accounts help investors, creditors, and internal company management understand how well a business is performing and of areas needing improvement.

Financial ratios are the most common and widespread tools used to analyze a business’ financial standing. Ratios are easy to understand and simple to compute. They can also be used to compare different companies in different industries. Since a ratio is simply a mathematically comparison based on proportions, big and small companies can be use ratios to compare their financial information. In a sense, financial ratios don’t take into consideration the size of a company or the industry. Ratios are just a raw computation of financial position and performance.

Ratios allow us to compare companies across industries, big and small, to identify their strengths and weaknesses. Financial ratios are often divided up into seven main categories: liquidity, solvency, efficiency, profitability, market prospect, investment leverage, and coverage.

• Liquidity Ratios
• Solvency Ratios
• Efficiency Ratios
• Profitability Ratios
• Market Prospect Ratios
• Financial Leverage Ratios
• Coverage Ratios
• Receivables Turnover Ratio
• Asset Turnover Ratio
• Cash Conversion Cycle
• Compound Annual Growth Rate
• Contribution Margin
• Current Ratio
• Days Sales in Inventory
• Days Sales Outstanding
• Debt Service Coverage Ratio
• Debt to Equity Ratio
• Dividend Payout
• Dividend Yield
• DuPont Analysis
• Earnings per Share
• Equity Multiplier
• Equity Ratio
• Fixed Charge Coverage Ratio
• Gross Margin Ratio
• Interest Coverage Ratio
• Internal Rate of Return
• Inventory Turnover Ratio
• Net Working Capital
• Operating Margin Ratio
• Payables Turnover Ratio
• Price Earnings P/E Ratio
• Profit Margin Ratio
• Quick Ratio – Acid Test
• Retention Rate
• Return on Assets
• Return on Capital Employed
• Return on Equity
• Times Interest Earned Ratio
• Working Capital Ratio

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• Retention Ratio
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• Sales to Admin Expenses
• Sharpe Ratio
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Home > Finance > Financial Ratio Analysis: Definition, Types, Examples, And How To Use

Financial Ratio Analysis: Definition, Types, Examples, And How To Use

Published: November 24, 2023

Learn everything about financial ratio analysis in finance, including its definition, types, examples, and how to effectively use it to make informed decisions.

• Definition starting with F

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Unlocking the Power of Financial Ratio Analysis

Understanding the financial health of a company is essential for investors, creditors, and even business owners. Financial ratio analysis is a powerful tool that helps to assess a company’s performance and make informed decisions. In this article, we will dive deep into the world of financial ratio analysis, exploring its definition, types, examples, and how to use it effectively.

Key Takeaways:

• Financial ratio analysis is a powerful tool to assess a company’s performance and financial health.
• It helps investors, creditors, and business owners make informed decisions.

What is Financial Ratio Analysis?

Financial ratio analysis is a method of evaluating a company’s financial health and performance by analyzing its financial statements. By comparing different financial ratios, we can gain valuable insights into various aspects of a company’s operations, including profitability, liquidity, solvency, and efficiency.

Types of Financial Ratios

Financial ratios can be broadly classified into four main categories: liquidity ratios, solvency ratios, profitability ratios, and efficiency ratios. Let’s take a closer look at each of these categories:

• Liquidity Ratios: These ratios measure a company’s ability to meet short-term obligations and assess its financial stability. Examples include the current ratio and the quick ratio.
• Solvency Ratios: Solvency ratios evaluate a company’s ability to meet long-term debt obligations. The debt-to-equity ratio and the interest coverage ratio are common examples.
• Profitability Ratios: These ratios indicate a company’s ability to generate profits relative to its revenue, assets, and shareholders’ equity. Examples include the gross profit margin, net profit margin, and return on equity.
• Efficiency Ratios: Efficiency ratios measure how well a company utilizes its assets and resources to generate sales and profits. Examples include the asset turnover ratio and inventory turnover ratio.

Using Financial Ratio Analysis

Financial ratio analysis is a versatile tool that can be used in various scenarios. Some common applications include:

• Comparing Companies: Financial ratio analysis allows investors and creditors to compare the financial performance of different companies within the same industry. This helps in identifying strong performers and potential investment opportunities.
• Evaluating Trends: By analyzing financial ratios over multiple periods, we can identify trends and spot any positive or negative changes in a company’s financial performance. This information is valuable for making predictions and forecasting.
• Assessing Risk: Financial ratio analysis helps identify potential financial risks by highlighting areas of concern such as high debt levels, low liquidity, or inefficient asset utilization. This knowledge allows investors and creditors to make more informed decisions.
• Measuring Efficiency: Ratios like the inventory turnover ratio and the asset turnover ratio help businesses assess their operational efficiency and make necessary improvements to maximize profits.

Bringing It All Together

Financial ratio analysis is an invaluable tool for understanding a company’s financial health and making informed decisions. By analyzing liquidity, solvency, profitability, and efficiency ratios, investors, creditors, and business owners can gain valuable insights into a company’s performance, compare companies, evaluate trends, assess risk, and measure efficiency.

So, whether you are a seasoned investor looking for the next promising stock or a business owner planning for growth, financial ratio analysis is an essential skill that can guide you towards success.

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What Is Financial Analysis?

• How It Works

Corporate Financial Analysis

Investment financial analysis, types of financial analysis, horizontal vs. vertical analysis, the bottom line.

• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Financial Analysis: Definition, Importance, Types, and Examples

Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a monetary investment.

Key Takeaways

• If conducted internally, financial analysis can help fund managers make future business decisions or review historical trends for past successes.
• If conducted externally, financial analysis can help investors choose the best possible investment opportunities.
• Fundamental analysis and technical analysis are the two main types of financial analysis.
• Fundamental analysis uses ratios and financial statement data to determine the intrinsic value of a security.
• Technical analysis assumes a security's value is already determined by its price, and it focuses instead on trends in value over time.

Investopedia / Nez Riaz

Understanding Financial Analysis

Financial analysis is used to evaluate economic trends, set financial policy, build long-term plans for business activity, and identify projects or companies for investment.

This is done through the synthesis of financial numbers and data. A financial analyst will thoroughly examine a company's financial statements—the income statement, balance sheet, and cash flow statement. Financial analysis can be conducted in both corporate finance and investment finance settings.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance.

For example, return on assets (ROA) is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several companies in the same industry and compared to one another as part of a larger analysis.

There is no single best financial analytic ratio or calculation. Most often, analysts use a combination of data to arrive at their conclusions.

In corporate finance, the analysis is conducted internally by the accounting department and shared with management in order to improve business decision-making. This type of internal analysis may include ratios such as net present value (NPV) and internal rate of return (IRR) to find projects worth executing.

Many companies extend credit to their customers. As a result, the cash receipt from sales may be delayed for a period of time. For companies with large receivable balances, it is useful to track days sales outstanding (DSO), which helps the company identify the length of time it takes to turn a credit sale into cash. The average collection period is an important aspect of a company's overall cash conversion cycle .

A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings or profit margin, into an estimate of the company's future performance. This type of historical trend analysis is beneficial to identify seasonal trends.

For example, retailers may see a drastic upswing in sales in the few months leading up to Christmas. This allows the business to forecast budgets and make decisions, such as necessary minimum inventory levels, based on past trends.

In investment finance, an analyst external to the company conducts an analysis for investment purposes. Analysts can either conduct a top-down or bottom-up investment approach.

A top-down approach first looks for macroeconomic opportunities, such as high-performing sectors, and then drills down to find the best companies within that sector. From this point, they further analyze the stocks of specific companies to choose potentially successful ones as investments by looking last at a particular company's fundamentals.

A bottom-up approach, on the other hand, looks at a specific company and conducts a similar ratio analysis to the ones used in corporate financial analysis, looking at past performance and expected future performance as investment indicators.

Bottom-up investing forces investors to consider microeconomic factors first and foremost. These factors include a company's overall financial health, analysis of financial statements, the products and services offered, supply and demand, and other individual indicators of corporate performance over time.

Financial analysis is only useful as a comparative tool. Calculating a single instance of data is usually worthless; comparing that data against prior periods, other general ledger accounts, or competitor financial information yields useful information.

There are two types of financial analysis as it relates to equity investments: fundamental analysis and technical analysis.

Fundamental Analysis

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company's earnings per share (EPS), in order to determine the business's value.

Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security's current price in order to see whether the security is undervalued or overvalued.

Technical Analysis

Technical analysis uses statistical trends gathered from trading activity, such as moving averages (MA).

Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to predict market movements by looking for patterns and trends in stock prices and volumes rather than analyzing a security’s fundamental attributes.

When reviewing a company's financial statements, two common types of financial analysis are horizontal analysis and vertical analysis . Both use the same set of data, though each analytical approach is different.

Horizontal analysis entails selecting several years of comparable financial data. One year is selected as the baseline, often the oldest. Then, each account for each subsequent year is compared to this baseline, creating a percentage that easily identifies which accounts are growing (hopefully revenue) and which accounts are shrinking (hopefully expenses).

Vertical analysis entails choosing a specific line item benchmark, and then seeing how every other component on a financial statement compares to that benchmark.

Most often, net sales are used as the benchmark. A company would then compare the cost of goods sold, gross profit, operating profit, or net income as a percentage of this benchmark. Companies can then track how the percentage changes over time.

Examples of Financial Analysis

In Q1 2024, Amazon.com reported a net income of $10.4 billion. This was a substantial increase from one year ago when the company reported a net income of $3.2 billion in Q1 2023.

Analysts can use the information above to perform corporate financial analysis. For example, consider Amazon's operating profit margins below, which can be calculated by dividing operating income by net sales.

• 2024: $15,307 / $143,313 = 10.7%
• 2023: $4,774 / $127,358 = 3.7%

From Q1 2023 to Q1 2024, the company experienced an increase in operating margin, allowing for financial analysis to reveal that the company earned more operating income for every dollar of sales.

Why Is Financial Analysis Useful?

The financial analysis aims to analyze whether an entity is stable, liquid, solvent, or profitable enough to warrant a monetary investment. It is used to evaluate economic trends, set financial policies, build long-term plans for business activity, and identify projects or companies for investment.

How Is Financial Analysis Done?

Financial analysis can be conducted in both corporate finance and investment finance settings. A financial analyst will thoroughly examine a company's financial statements—the income statement, balance sheet, and cash flow statement.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance. A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings or profit margin, into an estimate of the company's future performance.

What Techniques Are Used in Conducting Financial Analysis?

Analysts can use vertical analysis to compare each component of a financial statement as a percentage of a baseline (such as each component as a percentage of total sales). Alternatively, analysts can perform horizontal analysis by comparing one baseline year's financial results to other years.

Many financial analysis techniques involve analyzing growth rates including regression analysis, year-over-year growth, top-down analysis, such as market share percentage, or bottom-up analysis, such as revenue driver analysis .

Lastly, financial analysis often entails the use of financial metrics and ratios. These techniques include quotients relating to the liquidity, solvency, profitability, or efficiency (turnover of resources) of a company.

What Is Fundamental Analysis?

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company's earnings per share (EPS), in order to determine the business's value. Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security's current price in order to see whether the security is undervalued or overvalued.

What Is Technical Analysis?

Technical analysis uses statistical trends gathered from market activity, such as moving averages (MA). Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.

Financial analysis is a cornerstone of making smarter, more strategic decisions based on the underlying financial data of a company.

Whether corporate, investment, or technical analysis, analysts use data to explore trends, understand growth, seek areas of risk, and support decision-making. Financial analysis may include investigating financial statement changes, calculating financial ratios, or exploring operating variances.

U.S. Securities and Exchange Commission. " Amazon.com Form 10-Q for the Quarter Ended March, 31, 2024 ," Page 4.

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How to Write a Financial Analysis Report for Your Business

In this Article

Is your business worth investing in? For most of you, the answer is a definitive 'Yes.' But in the business world, talk is cheap. So if you want to attract investors, you'll need to be able to walk the talk, i.e., put your money where your mouth is. 

There's no better way to do that than with a financial analysis report. After all, numbers don't lie. They're the smoking gun investors need before investing in your business. 

Want to learn how to write a financial analysis report that attracts investors? This article covers six simple steps to follow. But first:

What is a financial analysis report?

A financial analysis report shows the financial performance of your business over a specified period of time, usually on a quarterly or yearly basis. It's like a medical report but for your business's financial health. 

In several countries, financial reporting is a requirement. The Securities and Exchange Commission requires companies to disseminate these digital reports to their shareholders in the United States. In addition, these financial reports are usually made available to the public if they're publicly-listed companies

A financial analysis report is invaluable to both you and your stakeholders. Let's discuss why you need it in the next section.

How does a financial analysis report help?

To make the right financial decisions for your business, you need data. This helps you lay a solid foundation for future performance and economic growth opportunities. 

However, you need to be able to keep track of and make sense of all your financial data. That's where a financial analysis report comes in. It helps you organize, analyze, and paint a clearer picture of your business's cash flow and allows for seamless management of business expenses too.

Aside from those, here are a couple of more reasons why you need a financial analysis report:              

Ensures transparency

A financial analysis report is easy on the eyes. It's a watered-down version of your finances that communicates essential data you need to make financial decisions. 

You ensure the transparency your stakeholders want, too. 

Tracks cash flow

Generally, financial reports help you understand cash inflows and outflows . For example, if you know your affiliate sales and operating expenses, the cost of getting links to increase website traffic , social media marketing campaign expenditure, and the money coming in, you can make better financial decisions. 

The information can help with debt ratios, budgeting, debt-to-asset financial ratio analysis, and calculating profit margins. 

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Allows for data-driven forecasting

Historical and real-time financial data help create financial models to predict future financial performance. These reports help you identify trends, patterns, and problems. As a result, you can plan for them early enough. 

Simplifies taxation

To create a financial analysis report, you must have all your data in a single document. It becomes easier for you to do your taxes, saves you time, and reduces the chances of making errors. Moreover, it's an official document that the Internal Revenue Service can use to calculate your taxes.

At the end of the day, the goal of a financial report is to provide insight into your organization's finances. Then, using both historical and current data, you can set SMART business goals to make better decisions for future performance. 

Finally, it's essential to consider the ongoing nature of financial analysis and the need for periodic reviews. Implementing a project review process allows you to regularly assess the financial health of your business, identify any emerging trends or issues, and make informed adjustments to your financial strategies. This continuous evaluation ensures that your financial analysis remains up-to-date and relevant, providing you and your stakeholders with accurate insights into your business's performance.

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Benefits of a periodic financial analysis

Financial analysis makes it easy for you to identify the strengths and weaknesses of your business. Using that information will not only help your business grow but also thrive. What's more, doing financial analysis over specific periods helps you stay on top of your game by:

Helping manage debts

A periodic financial analysis includes a financial ratio analysis; specifically, a Liquidity Ratio called the Current Ratio Analysis. The Current Ratio is the sum of all your current assets divided by the sum of your current liabilities. It shows if you're liquid enough to meet your upcoming debts. So, if you aren't, you can adjust your financial strategy the soonest.

Determining profitability

When you perform a periodic financial analysis, you can determine your company's profitability and make regular adjustments. A profitability ratio is a financial metric that can help you cut production costs and boost your bottom line. 

You can use a profitability ratio (featured below) to determine your profit margin on sales, i.e., your gross profit margin. Here's the formula. 

It's your sales revenue minus the total cost of goods sold (COGS) divided by revenue. 

Managing inventory

Another perk of doing financial analysis over a specific period is that it helps you better manage inventory . This way, you ensure it's always enough to meet projected sales. You do this using a financial management ratio called the Inventory Turnover Ratio. 

Calculate the Turnover Ratio by dividing your total sale by your inventory.  

Checking stability and revenue growth 

The results of a periodic financial analysis yield your debt-to-equity ratio, too. It's a financial metric that shows how you've raised capital for your business. You want to check your stability and revenue growth every step of the way to determine whether your business is viable in the long run.

The debt-equity ratio is calculated by dividing your total liabilities by your shareholder's equity. It's usually included when you write a financial analysis report. 

Generally speaking, the higher your debt-equity ratio, the higher the risk, and vice versa. Investors use this financial metric to check your company's stability and ability to raise money to grow. 

Optimizing for growth

Financial analysis over specific periods helps you identify opportunities to optimize operational efficiency for revenue growth. That is, regular annual reports help you spot patterns and trends. This allows you to nip problematic areas in the bud and prepare in advance. 

For instance, you can adjust seasonal sales fluctuations, variable costs, etc. 

How to write a financial analysis report

Now that you understand a financial analysis report's 'what' and 'why,' it's time to look at the 'how.' 

Here's how to write a financial analysis report:          

1. Give an overview of the company

The first section of your financial analysis report is the company overview. Here, you want to highlight the potential of your business. It's pretty much what you do in a business plan . Investors rely on your company overview to understand your competitive edge. 

The question you want to answer here is - is your business worth the investment you're asking for? Think of the introductions in business plans or on Shark Tank to give you a better idea. As a general rule of thumb, you want to use plain language when writing your description.

You want to share, in brief, your history, business model, type of organization, description, etc. You can share what sector you're in as well as the size and scale of your business. 

Featured below is an excellent example of a fictional company's overview.        

Start by reviewing your quarterly or yearly financing activities, financial data, and statements. Then go through published business studies and industry-specific trade journals. 

You should consider adding a snippet about how you compare to the industry average among your competitors. Like a business plan, you want to show potential investors why they should choose you. You can use Porter's Five Forces model to analyze your competition. 

2. Write sales forecast and other vital sections

It pays to be as precise and comprehensive as possible when writing the main content. So, you’ll need to organize your data and, sometimes, make some calculations yourself. For instance, when writing your sales forecast , you need your sales data for the past three years before you organize it in financial reporting software or spreadsheets. Tally the data on a yearly, monthly (for the 1st year), and quarterly (for the last two years) basis. 

You can write this part using a spreadsheet. But feel free to use financial reporting software if spreadsheets aren’t your cup of tea. 

There are other sections you should create for your report’s main body. 

Let’s look at them one by one:

• Expense budget

With your sales forecast in place, it's time to figure out how much it'll cost. When setting up your expense budget , ensure it includes variable costs like your marketing budget and fixed costs like rent. In addition, you'll need to create an estimate for items like interest and taxes. 

• Cash flow statement

A cash flow statement summarizes all the money or its equal coming in (cash inflow) or leaving (cash outflow) a business. To create one, you need historical financial data or project it one year ahead if you're starting. Don't forget your cash flow statement is connected to your invoice.

• Estimate for net profit

Tally your net profit using your sales forecast, expense budget, and cash flow statement data. Your net profit margin is your gross margin less taxes, interest, and expenses. Try and be as precise as possible since this can stand in as your profit and loss (P&L) statement . 

• Estimate for assets and liabilities

Your next step is to calculate your company's net worth. How? By managing your assets and liabilities, i.e., those items that don't appear in your P&L statement. 

To do that, ballpark your monthly cash on hand. That is, equipment, inventory, land, and accounts receivable. Then sum up your liabilities, i.e., outstanding loan debts and accounts payable. 

• Break-even point

The last step in writing a company financial analysis report is calculating your break-even point. That's where your business expenses match your sales volume. Use the formula below to find your three-year sales forecast; this will help you find your break-even point.

Needless to say, if you're operating a profitable business model, then your company's revenue should be higher than your operating expenses. Again, this information helps reassure potential investors of your business' stability and revenue growth potential.  

Refrain from assuming that people know the concepts you'll discuss in your report. Instead, define them in general terms first before you start talking about specifics.

3. Determine the company's valuation

The company valuation part is one of the most critical sections of your financial analysis report. Why? Because it helps potential investors see the value of investing in your company. 

To determine your business' valuation is to find your company's value. You do this by analyzing your company data, including all the data you have discussed. There are three main ways to do it, i.e., using the following: 

• Discounted Cash Flow (DCF) Analysis
• Book Value Analysis
• Relative Value Method

The goal here is to outline your current assets and liabilities. Moreover, the above techniques help you determine your business' stocks and current value. To do this, most accountants or financial officers use insights from and final average accounts of your balance sheet. 

4. Perform risk analysis

Risk analysis helps potential investors see your company's investment potential. That includes both current and future risks. You can start risk analysis by running a SWOT analysis . 

But remember that your SWOT analysis is microscopic. So for the best results in your valuation, combine it with other techniques. For example, doing a PESTLE analysis . Here's a template you can use for that:

A PESTLE analysis gives you more details and offers two main benefits. First, it helps you understand your marketing environment and other macro factors that affect your company's financials. 

5. Include summaries of financial statements

When writing the financial analysis report of a company, you need to include a brief overview of your company's financial statements. To do this, summarize each component of the 3-statement model:

Let's discuss each of them:

Cash flow statement. Potential investors look at your cash flow statement summary for two reasons. One, it lets them see if you make enough money to settle your debts. Two, it helps them decide whether your company is worth investing in.

Income statement . A summary of this does two things. First, it shows you gaps in increasing operating profit by allowing you to boost sales revenue , reduce cost, or both. It's also an income statement showing how effective your strategies are at the start of your financial year.

Balance sheet. The balance sheet shows your debt coverage and asset liquidity in real time. The difference between assets and liabilities gives you the 'owner's equity.' Here's an example of a balance sheet:

Note that summarizing each of these three components doesn't mean just including tables in your report. Instead, explain what the data means in paragraph form, too.  

6. Summarize the entire report 

The last section of the financial analysis report of a company is a summary. You want to share your final views about the company and your opinion on whether it's a profit or loss. That said, be sure to substantiate all your claims. 

That means having evidence containing factual data, financial accounts, and proven financial theories. You can also include the outlook of the company. That is the type of organization, industry trends, economic growth strategies, and how they'll affect the company. 

In conclusion

By now, you should understand the value of a company financial analysis report and how to write one. Not only does it show you the financial health status of a company, but it's also the smoking gun investors look for before investing in any business. 

To any organization, a financial analysis report is a compass to optimize operational efficiency for growth. It is also a crucial part in portfolio management especially when you need to open your business up to other stakeholders.

Summarising, to write a financial analysis report, you need to: 

Write your company overview , sales forecast, and other essential sections. Once those are out of the way, you can perform company valuation and risk analysis. Then, all that's left is to summarize what was discussed. 

Daryl Bush is the Business Development Manager at Authority.Builders . The company helps businesses acquire more customers through improved online search rankings. He has extensive knowledge of SEO and business development.

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328 Financial Ratio Analysis Research Papers & Essay Examples

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BusinessEssay. (2022, December 21). 328 Financial Ratio Analysis Research Papers & Essay Examples. https://business-essay.com/analyses/financial-ratio-analysis-research-paper-examples/

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Almarai Company: Key Financial Ratios Analysis Essay

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Almarai Company (Almarai) is a large conglomerate based in Saudi Arabia, which specializes in manufacturing and distributing food and beverages. It is the largest dairy company in the country, with sales exceeded SAR 13 billion in 2018. Its stock id is 2280, and the current share price is SAR 51.40. This report presents a financial statement analysis of Almarai along with the calculation of key financial ratios compared with the industry averages. The analysis is based on the financial reports of the company for the last two years.

Table 1 presents the trend analysis of Almarai’s Consolidated Statement of Financial Position and Consolidated Statement of Profit or Loss in a summarized way.

Table 1. Trend Analysis.

Table 2 presents the common size statement analysis of Almarai’s Consolidated Statement of Financial Position and Consolidated Statement of Profit or Loss in a summarized way.

Table 2. Common Size Analysis.

The trend analysis indicates that the current assets, excluding inventory, of Almarai declined by 12.4% in 2018. Its inventory increased by 24.1%, which highlighted a slowdown in the company’s international sales. The company increased its investments in 2018 to generate income from other sources. The total assets increased by 1.3%, but its shareholders’ equity declined by 3.8%. It implies that the company had to raise funding for its assets by acquiring additional liabilities. Furthermore, the company’s sales and cost of sales reduced in 2018. The company’s net income declined by 7.1%, which could raise concerns among shareholders about its future profitability.

The vertical analysis of Almarai’s financial position indicated that its fixed assets were almost 70% of its total assets. It is also noted that the company’s inventory as a proportion of total assets increased from 9.8% in 2017 to 12% in 2018. Although the company’s current liabilities reduced, Almarai’s non-current liabilities increased as a proportion of total liabilities. Finally, the shareholders’ equity also declined in 2018. The analysis of Almarai’s statement of profit indicates that the cost of sales increased from 59.9% in 2017 to 60.3% of sales in 2018, which also affected its gross margin. The company maintained the same allocation to its admin and marketing expenses in both years. Almarai’s business is registered in Saudi Arabia and does not pay taxes; instead, it made a zakat contribution of 0.5% in 2018. The company’s net profit reduced from 15.5% in 2017 to 14.6% in 2018. However, it could be stated that the profitability of Almarai remained strong in both years.

The financial ratio analysis calculates the values of key financial ratios provided in Table 3.

Table 3. Financial Ratio Analysis.

The current ratio of Almarai improved to 1.31 in 2018 but was lower than the industry average of 1.36. The short-term liquidity position of the company was regarded as weak because its quick ratio value was less than one and lower than the industry average. The asset turnover of the company slightly declined in 2018 and was lower than the industry average. The net profit margin of Almarai reduced from 0.155 in 2017 to 0.146 in 2018 but was higher than the industry average of 0.1048. The equity multiplier value increased in 2018 that indicated that the proportion of assets financed by the company’s equity decreased.

The ROE was 13.83% in 2018, which was less than the industry average. Similarly, its ROA was less than the industry average, and the company only generated SAR 0.06 in revenue for every SAR 1 in assets. The Debt to Equity ratio value indicated that the company had high leverage, which was also greater than the industry average.

The accounts receivable turnover declined in 2018 and was less than the industry average. It implies that the company took a long time to receive cash for its credit sales. The allowance for doubtful trade receivables was SAR 76.824 million and SAR 57.333 million in 2017 and 2018, respectively. It indicated that this allowance was almost 4% of the total trade receivables, which was a significant value.

There is no change in the method of recording inventory, and the company uses the periodic method of accounting for inventory that records all purchases and sales continuously and updates the purchase account at the end of the period. The company’s inventory increased by 24.1% in 2018, and its inventory turnover was just 2.14 in 2018 as compared to the industry average of 3.59. It implies that Almarai’s business efficiency weakened in 2018 as it did not manage its inventories effectively that resulted in a high cash amount held in non-income generating items. The company’s total assets were SAR 32.318 billion in 2018, and its total liabilities were SAR 17.802 billion. The company’s goodwill was SAR 1.038 billion in 2018, which was less than its value in 2017 due to its impairment. Almarai recorded goodwill upon the acquisition of three companies in 2007, 2009, and 2012.

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