Interpretation of Financial Ratios

total assets

Accountants do for capital leases what we suggested that they need to do for operating leases. One cost of having them do it is that you do not control when the present value is computed and the pre-tax cost of debt used. Marginal tax rate Tax rate on last dollar or next dollar of income. Measures the taxes you will have to pay on additional income that you will generate on new investments and the savings that you will obtain from a tax deduction. The marginal tax rate is best located in the tax code for the country in which a company operates.


The ratios make more sense when compared with results of similar firms, the firm’s own historical performance, or the industry average. Financial ratio analysis uses the data contained in financial documents like the balance sheet and statement of cash flows to assess a business’s financial strength. These financial ratios help business owners and average investors assess profitability, solvency, efficiency, coverage, market value, and more. Financial statement ratios are calculated using the financial statement of a company to analyze and assess a company.

What do financial ratios show you?

Perhaps the type of ratios most often used and considered by those outside a firm are the profitability ratios. Profitability ratios provide measures of profit performance that serve to evaluate the periodic financial success of a firm. One of the most widely-used financial ratios is net profit margin, also known as return on sales. It measures a company’s ability to generate net profit from each dollar of revenue. It not only takes into account operating income , but also non-operating income such as sales of fixed assets, interest income , gains , and tax expense.

This category evaluates the ability of the hospital to generate cash for normal business operations. A worsening liquidity position is usually a primary indication that a hospital is experiencing financial distress. Analysis of financial ratios is widely undertaken by analysts, commentators and credit rating agencies whenever a company posts results or plans a merger or acquisition. Here, for example, S&P Global Ratings considers the impact of a proposed acquisition on ONGC’s financial ratios. It is used to discern how well a business can generate a profit from both its operations and financial activities.

Leverage ratios

These companies tend to report “revenue” based on the monetary value of income that the services provide. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. Standard deviation is a measure of variation of a dataset relative to its mean.

For example, if the P/E ratio of all companies in the S&P 500 index is 20, and the majority of companies have P/Es between 15 and 25, a stock with a P/E ratio of seven would be considered undervalued. In contrast, one with a P/E ratio of 50 would be considered overvalued. The former may trend upwards in the future, while the latter may trend downwards until each aligns with its intrinsic value.

Ratio Analysis Across Companies

There are several standard ratios people use to evaluate the overall financial condition of a company. A solvency ratio is a key metric used to measure an enterprise’s ability to meet its debt and other obligations. A debt-equity ratio that might be normal for a utility company that can obtain low-cost debt might be deemed unsustainably high for a technology company that relies heavier on private investor funding. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. For this type of ratio analysis, one can use the formula below for the same. If the ratio is less than 1, one can use it to purchase fixed assets.

ratio measures

(See Non-cash ROE for a variation) Return earned on equity invested in existing assets. Compared to the cost of equity to make judgments on whether the firm is creating value. The book value of equity is assumed to be a good measure of equity invested in existing assets. This assumption may not be appropriate if that number is skewed by acquisitions or write-offs . In contrast, a cost leadership strategy promotes a lower cost structure than the industry.

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