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24th June 2010

Important Ratio concepts

Important Ratio concepts

MEANING
Ratio Analysis is very important concept to judge a company's fundamentals,
it can be said that it is a tool used to conduct a quantitative analysis of information in a
company's financial statements like Profit and Loss account, Balance sheets and cash
flow statement . With the help of past data u can judge the companies current financial
performance.
IMPORTANT RATIOS
1)Debt Equity Ratio
2)Current ratio
3)ROCE- return on capital employed
4)RONW- Return on net worth
5)PBITD margine\
6)PAT margine
7)Cash Profit Margin
This seven ratio is important to judge the company's financial health.

Debt to Equity:
The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of
shareholders' equity and debt used to finance a company's assets. It is used to
determine whether a government agency, business, household, or other entity can
safely borrow over long periods of time.
Assets are important because your lender may be unwilling to loan you any more
money if your debt-to-equity ratio exceeds a certain figure. If sales and assets grow at
the same rate, your debt-to-equity ratio should remain within the lender's limit, allowing
you to borrow to finance growth forever.
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A ratio greater than one means assets are mainly financed with debt, less than one
means equity provides a majority of the financing.
If the ratio is high (financed more with debt) then the company is in a risky position especially if interest rates are on the rise.For further clarification you can read the
leverage concept:
Formula:
Debt/Shareholders Equity

Current Ratio:

The current ratio is a financial ratio that measures whether or not a firm has enough
resources to pay its debts over the next 12 months. It compares a firm's current assets
to its current liabilities. An indication of a company's ability to meet short-term debt
obligations; the higher the ratio, the more liquid the company is.
Acceptable current ratios vary from industry to industry, but a current ratio between 1
and 1.5 is considered standard. If a company's current assets are in this range, then it
is generally considered to have good short-term financial strength. If current liabilities
exceed current assets (the current ratio is below 1), then the company may have
problems meeting its short-term obligations. If the current ratio is too high, then the
company may not be efficiently utilizing its current assets.
In general, a quick ratio of 1 or more is accepted by most creditors, in which u consider
the most liquid Current assets.
Formula:
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Current Assets/Current Liabilities

ROCE:
The prime objective of making investments in any business is to obtain satisfactory
return on capital invested. Hence, the return on capital employed is used as a measure
of success of a business in realizing this objective. It is the best measure of profitability
in order to assess the overall performance of the business. It indicates how well the
management has used the investment made by owners and creditors into the business.
ROCE should always be higher than the rate at which the company borrows; otherwise
any increase in borrowing will reduce shareholders' earnings.
ROCE tells us how much profit we earn from the investments the shareholders have
made in their company.
A negative ROCE would mean that the firm had made a loss.
ROCEs are typically between 5% and 15%. This will depend on the sector in which the
firm operates.

Formula:
EBIT/Capital Employed

RONW:
This ratio gives you an idea of the returns generated by investing in the company.
While ROCE is an effective measure to get a general overview of the profitability of the
company's business operations, RONW lets you gauge the returns you can earn on
your investment. This ratio indicates the return on stockholder's total equity.
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RONW/ROE is the single most important financial ratio applying to stockholders and the
best measure of performance by a firm's management.
A high return on equity indicates that the company is spending wisely and is likely
profitable; a low return on equity indicates the opposite. As a result, high returns on
equity lead to higher stock prices.
A negative RONW would mean that the firm had negative earning.
Formula:
PAT/Net Worth

PBITDM:
PBITDM margin measures the extent to which cash operating expenses use up
revenue. PBITDM margin is often more useful than operating margin for the same
reasons that EBITDA is more useful than operating profit (EBIT) - it excludes non-cash
items such as depreciation.
Generally, a higher value is appreciated for this ratio as that would indicate that the
company is able to keep its earnings at a good level via efficient processes that have
kept certain expenses low.
However, when comparing company's EBITDA margin, make sure that the companies
are in related industries as different size companies in different industries are bound to
have different cost structures, which could make comparisons irrelevant.
Negative EBITDA margin means that company is running in operating loss.
Formula:
EBITDA/Gross Sales
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PATM:
A company's after-tax profit margin is important because it tells investors the
percentage of money a company actually earns on sales. This ratio is interpreted in the
same way.
For example, a company's sales could increase, but if costs also rise, that leads to a
lower profit margin than what the company had when it had lower profits. This is an
indication that the company needs to better control its costs.
Thus, it helps to measure of how well a company controls its costs after taxes.
A high after-tax profit margin is generally seen as better if it is at all feasible.
A low after-tax profit margin is not necessarily a negative sign. Some companies and
industries are expensive to run and have low margins by their nature.
Formula:
PAT/Gross Sales

CPM:
cash profit margin ratio is used to measure operating performance.
Formula:
(Pat+Dep)/Gross Sales

so these are the very important concept for fundamental analysis

Posted 24th June 2010 by Anuradha Gupta
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Anonymous December 3, 2010 at 5:31 PM

It's provide basic knowledge of ratio and also helpful for analyzing any balance
sheet.
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