Intro to Financial Ratios

Financial Ratios are commonly talked about and used on wall Street. What financial ratios do is give the analyst insight into a company. They are also used for bench-marking purposes. Bench-marking shows you how a company is doing compared its peers. You can easily find this data on any company by searching Yahoo Finance already calculated for you.



There is reason why finical ratios are in the accounting section. Auditors of public companies will check finical ratios as a benchmark to spot things that don’t look right. Sometimes these create a clear picture for them when something is wrong, too good to be true, or if the company is on the verge of failure. 

Two Types Main Tools of Fundamental Analysis

Qualitative

This is analyzing things that can’t be explained through numbers when you are analyzing a company. Some examples would be management’s style, branding, new contracts not monetized, a major increase or decrease in demand for a companies product etc.  I could continue listing these but they are basically things that can’t be calculated on a financial statement. This is an important part of fundamental analysis.

Quantitative

Think of quantified analysis as the mathematical analysis of a company. Financial ratios fit into this category and after you understand them they tell a story of their own.  In the world of Finance; however, there are statistics used to analyze stocks. As an example, a beta tells you how volatile a stock is compared to the overall market. This is a way to judge the risk of a stock compared to its peers.

What do Financial Ratios Teach Us?

Chart of Financial Ratios

Company Positions

Without financial ratios, it can be difficult to see if a company is doing better or worse over financial reporting time periods.  This is due to the fact that companies are growing and shrinking; also, some companies are seasonal , so these ratios are sometimes an indicator of where the company stands.

Benchmark

A benchmark is a term used in the business world to describe what the overall average is. I will use a benchmark often quoted in the investing and trading world. Someone will say, “XYZ outperformed the market by 10%.” What this is telling us is that company XYZ is a better performer than the market. To learn more about bench marking go to the stock index page.

Liquidity Activities

The term liquidity is used to describe a firms ability to pay their current liabilities as the come due. These ratios often involve a variation of current assets and current liabilities in the short run. When someone states that something is short run it can mean two things. The short run is often considered less than one year. The second definition is a companies operating cycle which is normally less than one year.



Long Term Obligations

In the accounting section, I go over long-term debt on the balance sheet. As an investor, it is important to analyze the companies long term debt and how well they manage it.

Profitability/ Efficiency

There are financial ratios that are used to tell you if profitability and efficiency is increasing or decreasing. The reason why I included efficiency in this is because a company can become more profitable by working more efficiently and this can reduce costs and increase profitability.

Value

Some of these financial ratios are used to give investors an idea of the value of a company. These ratios normally make a comparison between the companies peers or the market value to book value. This is the way that Wall Street judges value when it comes to the stock market.

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