Financial Ratios
Financial Ratio term indicates about the performance of the company and allows to perform quantitative analysis to have better knowledge about the company. Benjamin Graham was the father of fundamental analysis. It always compares with the previous year’s performances or with the other companies of same industry (Seegmiller, 2023). The financial ratio uses the company’s financial data to analyze. Managers use the ratios analysis to get an idea about the weakness and strengths of the company which helps to improve their strategic plans. The financial ratios analysis helps the analysts or the experts of finance to calculate the future profits of the company by the past performances (Bloomenthal, 2024). There are four different types of financial ratios such as profitability ratios, leverage ratios, valuation ratio and operating ratio.
Profitability Ratios
Profitability ratios describe how a company is going to generate profits from its functions. It is a type of financial ratio which helps in finding the financial performance of the company profits with regard to the revenue, balance sheets, operating costs, and shareholders’ fairness over a specific time period (Baltova, 2023). The profitability is again divided into six categories such as PAT and PAT margin growth, EBITDA margin, and EBITDA growth, return on equity (ROE), Return on asset (ROA), Return on capital employed (ROCE), and earnings per share (EPS).
PAT and PAT Main Growth
PAT refers to profit after tax which describes how much a company earned after all the income tax deductions. Profit after tax is calculated by subtracting the total profit before tax from the total tax rate. Every investor and shareholder look at the profit after tax to analyze the financial state and performance of the company. Profit after tax margin is the state of financial presentation which calculates the net income of a company and net sales (Astuti, 2021). Profit after tax margin is calculated as the ratio of net revenue of the company and the net sales of that organization. This is helpful to the investors to compare one company’s tax margin to other companies in the same industry.
EBITDA & EBITDA Margin
EBITDA means earnings before taxes, Amortization, depreciation and interest which is used to estimate the operating performance of the organization and mostly dependent upon the company’s capital resources. It is calculated as operating profit plus depreciation and amortization. The business owners might benefit from using EBITDA to know the value of their business, which includes operating costs. EBITDA margin describes the income before taxes, depreciation, interest and amortization, and the margin defines the capital that is leftover after all the payments except interest, taxes, and other charges. This helps us to compare with other companies in the same industry in accordance with the profitability and accounting rules.
Return On Equity (ROE)
Return on equity is defined as consideration of the real wages of the organization and the fairness of the share owners. The net income indicates overall the income of the company, expenses, taxes which a company generates in a certain period. Return on equity describes about the percentage of the company how good it is performing and managing the financial allowances from their shareholders. It is calculated as the ratio of the net income of the company and the equity of the shareholders. High return on equity indicates that it does not need any more debts and loans, which helps to avoid the interest expenses.
ROE vs ROCE
Return on equity (ROE) and return to capital employed (ROCE) both are crucial factors of finance but measuring different things. ROE determines how the organization uses shareholders’ equity to gain profits whereas ROCE determines how the company uses its revenue to get the earnings. ROE is the consideration of both equity and borrowed capital, but the ROCE considers only equity. The higher ROE indicates effective usage of the equity, and the higher ROCE helps to suggest better management of the overall capital. ROCE is helpful for the companies with higher debt and the ROE works with the organizations with high dependence on fairness.
Return on Asset (ROA)
Return on asset describes about how the company is successfully generating the capital from its resources. The higher percentage of the return on asset indicates that the company is using their resources well and the higher number indicates that the company is generating the high profits with less resources. Return on assets calculated as the ratio of net income of the company and the total resources used. The ROA ratio helps investors and executives of the company to compare with other companies in the same industry.
Return on Capital Employed (ROCE)
Return on capital employed defined as the financial ratio of the company which helps to understand the capital and profit. It also indicates the company’s profitability by taking consideration of the overall capital it employes. The shareholders and investors might benefit from the return on capital employed to analyze the purpose of investment. Return on capital employed is the ratio of the earnings before interest, tax (EBIT) and the capital employed. EBIT is total assets subtracted from current liabilities. Compared to the other fundamentals like return to equity considers only the profitability of the company’s shareholders but the Return on capital employed helps to include the debt and equity also (Hayes, 2024).
Earnings Per Share (EPS)
Earnings per share describes the net income of the business and how much the shareholders earn per share if a company sells their shares. EPS explains about the current and future profitability of the company. This is helpful to understand the financial growth and knowledge of the company. Therefore, Earnings per shares are the ratio of the net profit and the number of common outstanding stocks of the corporation. It is helpful in comparing several companies’ performances and choosing the suitable investment options that might match the investment goals of a company. above all, consistency of the earnings per share defines profitability and making company for the good investment.
Leverage Ratios
Leverage Ratios are type of financial measurement that focus on how much capital comes in the form of debt for the company or estimates the capacity of the company that meets its financial responsibilities. So, the leverage ratio is the ratio of total assets by total fairness. There are four different leverage ratios such as financial leverage ratio, interest coverage ratio, debt to asset ratio, debt to equity ratio. The leverage ratio of a company is helpful to the investors to identify the level risk of that is associated with the other company. Leverage ratios might vary from one industry to another industry.
Interest Coverage Ratio
Interest coverage ratio helps to identify and recognize how much the firm is gaining with respect to the debt burden. Interested coverage ratio is considers as EBIT separated from the interest payment of the company. An extremely low debt indicates the healthy finance state of the company. It is the percentage between the total charges and shareholders’ equity. The higher interest coverage ratio will be beneficial whereas the ideal ratio will vary from one industry to another industry. The interest coverage ratios focus on how fast the company will pay their interest due on the outstanding debt.
Debt to Equity Ratio
Based on analysis it measures the total balance principle with respect to the total fairness capital of the company. If the debt-to-equity ratio is equal to one, then it describes that the identical amount of debt and total justice capital (Tyre, 2022). In addition, Debt to equity is an equation deveops the total debt divided by the total equity. The investors are able to modify the debt-to-equity ratio to consider the long-lasting risks. Therefore, Debt to equity ratio shows the difference from one industry to another industry, which is good to compare direct competitors of the company. A higher debt to equity ratio is more risk compared to the lower one as the company is not taking the financing debt to expand.
Debt to Asset Ratio
The debt to asset ratio describes the comparison of a company’s long-term with short-term responsibilities to their total assets. If a company is having high debt to asset ratio, then it is having high debt percentage. The debt to asset is all about growth of the business in the time of accounting and preparing financial estimations.
Financial Leverage Ratio
The financial leverage ratio describes the capability of the firm to meet its long-term and short-term goals and responsibilities. It is the process of getting money from other sources in order to purchase some goods or services that are necessary. The financial leverage ratio is the ratio of the total assets to the total equity of the organization. This ratio helps to increase the possibility of investments from the investors.
References
Astuti, W. (2021). A Literature Review of Net Profit Margin. Social Science Studies, 1(2), 115-128.
Baltova, A. (2023, May 30). Profitability Ratios – Definitions, Types, Formulas. Retrieved from 365 Financial Analyst: https://365financialanalyst.com/knowledge-hub/financial-analysis/profitability-ratios/
Bloomenthal, A. (2024, February 26). Financial Ratio Analysis: Definition, Types, Examples, and How to Use. Retrieved from Investopedia: https://www.investopedia.com/terms/r/ratioanalysis.asp
Girsch-Bock, M. (2024, May 10). A Guide to Calculating and Interpreting Your Debt-to-Asset Ratio. Retrieved from The Ascent: https://www.fool.com/the-ascent/small-business/accounting/debt-to-asset-ratio/
Hayes, A. (2024, June 20). Return on Capital Employed (ROCE): Ratio, Interpretation, and Example. Retrieved from Investopedia: https://www.investopedia.com/terms/r/roce.asp
Seegmiller, T. (2023, February 15). Financial Ratios – What Are They And How Can You Use Them? Retrieved from Vena Solutions: https://www.venasolutions.com/blog/financial-ratios
Tyre, D. (2022, August 3). Debt to Equity Ratio, Demystified. Retrieved from Hubspot: https://blog.hubspot.com/sales/debt-equity-ratio