Financial Ratio Analysis: Definition, Types, Examples, and How to Use

financial statements

A high receivables turnover ratio shows that a company quickly generates cash from accounts receivables. Other important financial ratios may require analysis of disclosures in other parts of the bank’s financial statements. There are generally five types of financial ratratios1) profitability, liquidity, management efficiency, coverage, valuation, and solvency.

Financial ratio analysis assesses the performance of the firm’s financial functions of liquidity, asset management, solvency, and profitability. Financial ratios oraccounting ratiosmeasure a company’s financial situation or performance against other firms. The ratios also measure against the industry average or the company’s past figures. Debt ratios quantify the firm’s ability to repay long-term debt.

How analysts and external stakeholders use Financial Ratios

Many like to compare the current price of the firm’s common stock with its book, or break-up, value. As the name suggests, we calculate the debt to assets ratio by dividing total debt by total assets. The total debt I mean here is interest-bearing debt, both short-term and long-term. This ratio shows us whether the company’s current assets are sufficient to pay its short-term liabilities. A current ratio value equal to 1 is usually a limit, which means current assets are equal to current liabilities.


But, as a note to us, a high receivables turnover ratio can also occur due to too-strict credit terms or collection policies. It can hurt sales if competitors offer customers more lenient credit terms. For example, companies may stockpile goods in warehouses due to sales problems. Or, the company rebuilds its inventory too quickly even though market demand is still weak. Assess the company’s ability to meet its liabilities (short-term and long-term). Forecast future cash flows and how quickly a company can convert sales into cash.


Managers attempt to increase this ratio, since a higher turnover ratio indicates that the firm is going through its inventory more often due to higher sales. A turnover ratio of 4.75×, or 475 percent, means the firm sold and replaced its inventory stock more than four and one-half times during the period measured on the income statement. For example, if total liabilities are valued at $5 million and total assets are valued at $10 million, then the debt-to-assets ratio is 0.5 This means that half of the assets are leveraged by debt. This could be good or bad depending on the industry and the history of the competitors.


Financial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices. Large multi-national corporations may use International Financial Reporting Standards to produce their financial statements, or they may use the generally accepted accounting principles of their home country. Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare. The dividend payout ratio represents the percentage of a company’s net income that was paid out to shareholders as dividends. While older companies pay out a larger portion of their earnings to shareholders, young businesses may have a low or even 0% payout ratio.

Lisa kommentaar

Sinu e-postiaadressi ei avaldata. Nõutavad väljad on tähistatud *-ga

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>