Ratio Analysis

Question 1

What is a ratio?

Answer 1

relationship between two numbers expressed in comparison to “1,” such as 5:1.

In ratio analysis, we compare numbers taken from financial statements

In summary, ratio analysis is the
use of various ratios to analyze
financial statements and the
financial health of a company

Question 2

Why do we use Ratio analysis?

Answer 2

Ratio analysis enables the business to
– spot trends
– compare its performance and condition with the average performance of similar businesses in the same industry

Comparing ratios for successive years may discover unfavourable problems that may be arising
– Ratio analysis may provide the early warning of problems that may potentially destroy the business
– It’s critical to properly interpret ratios.

Question 3

What are the three categories of Ratios?

Answer 3

Liquidity Ratios
Efficiency Ratios
Profitability Ratios

Question 4

What do these categories mean?

Answer 4

Liquidity ratios – measures the liquidity of the company. These ratios are important in measuring the ability of a company to meet both its short term and long-term obligations.

Efficiency ratios – measures the efficiency of a company in either turning their inventory, sales, etc. It also ties into the liquidity of a company.

Profitability ratios – shows the ability of a company to get returns or profits on the investment the owners made.
– If a business is liquid and efficient it should also be profitable.

Question 5

What are the Liquidity Ratios

Answer 5

There are three main liquidity ratios:
1. The Current Ratio
2. The Quick Ratio
3. The Debt to Equity Ratio

Question 6

What are the efficiency ratios?

Answer 6

here are three main efficiency ratios:
1. The DSO (Days Sales Outstanding) Ratio
2. The Inventory Turnover Ratio
3. The Accounts Payable to Sales (%) Ratio

Question 7

What are the profitability ratios?

Answer 7

here are three main profitability ratios:
1. The Return on Sales OR Profit Margin (%)
2. The Return on Assets
3. The Return on Equity

Question 8

What are other important ratios?

Answer 8

Other Important Ratios for Investors
1. Earnings Per Share (EPS)
2. Price/Earnings Ratio
3. Price/Earnings to Growth (PEG) Ratio
4. Dividend Yield