There is a lot more stuff to say something about the company’s operating health. Long term investors are lean to judge how a company is performing over a period of time in order to lend their money to them. You might have frequently learned and listened about using the financial statements to judge a company’s financial health and performance. The most common and frequently used way to analyze the financial statements is ratio analysis. However the financial calculators have made this creepy task so easier as it was never before in the course of analysis. In the present time, even you can have pre calculated ratios in the financial statements of the company. Now your task is to understand the meaning of numerical language in order to interpret them effectively and use them efficiently in effective decision making. There are four basic types of ratios:
- Performance Ratios
- Activity Ratios
- Financing Ratios
- Liquidity Ratios
In the underlying article, we have the top most five ratios explained that count a lot in stock investment decision making process.
- Debt to Equity Ratio
While quantifying the company’s financial leverage, here we go to divide total liabilities of a firm by stockholders’ total equity. It basically points out the proportion by which a company induces debt and equity to its capital expenditures. A higher debt to equity ratio alarms a company that it is using more debt to cater its need. This is not a motivational sign for the prospective investors. However a lower (usually less than 1) is good.
- Current Ratio
It is a measure of liquidity ratios. It indicates the overall capacity of a company to repay its short term obligations (debts). The underlying ratio is also known as cash to asset ratio. Higher value of current ratio is favorable in company’s ranking. The higher the ratio, the higher its capacity is to repay its short term obligations. It is calculated by dividing Current Assets by Current Liabilities of the company.
- Quick/ Acid Test Ratio
It is also known as quick asset ratio. It is calculated by dividing the difference between current assets and inventories (Current Assets – Inventories) by the Current Liabilities of a company. A higher numeric value in return of acid test ratio is a favorable sign for company’s financial health ranking. It measures the company’s short term debts in comparison to its current assets.
- Return on Equity (ROE)
It is a numeric figure justifying the percentage of net income returned back on stockholders’ equity. Higher the percentage means higher the profitability. Dividend seekers usually take decision on the basis of ROE broadly. It is calculated by dividing the Net Income by Total Shareholders’ Equity.
- Net Profit Margin
It shows the overall profitability of the company. Since it is the gross figure then it is most prominent one. It is the reported figure which is found in news and reviews about a company. It is calculated by dividing the Net Profit by Net Sales. It is reported in the form of percentage and higher figure is favorable.by