financial ratios

Cash Flow Statement

  • Understanding Financial Statements

    • Key financial statements include the Cash Flow Statement, Income Statement, and Balance Sheet.

    • Knowing where gross profit, sales, and equity are located in these statements is essential.

Average Equity

  • Definition

    • Average equity is calculated as (Opening Balance + Closing Balance) / 2.

    • Important to know the placement of equity on financial statements.

  • Calculation Example:

    • If equity at the beginning of the year is $50,000 and at the end is $70,000, the average equity = (50,000 + 70,000) / 2 = $60,000.

Financial Ratios

  • Purpose of Financial Ratios

    • Ratios derived from financial statements help understand company performance regarding profitability, efficiency, and liquidity.

    • Important for investors to gauge operational health; however, they should not be the sole factor for investment decisions.

  • Limitation of Ratio Analysis

    • Ratios provide a simplified view and can miss other critical factors like market reputation, inflation, or timeliness of reports.

Operational Ratios

  • Types of Ratios:

    • Profitability Ratios (e.g., Gross Profit Margin) indicate income success relative to resources used.

    • Liquidity Ratios evaluate a business's ability to meet short-term obligations.

  • Ratios to Know:

    • Gross Profit Margin = (Gross Profit / Sales) * 100

    • Operating Profit shows company's efficiency in using assets.

Cost Analysis

  • Cost of Goods Sold (COGS)

    • Understand its relation to inventory and sales. COGS typically found in the Income Statement.

  • Calculating Changes

    • Changes need to be monitored over periods to analyze trends (e.g., increase in revenues should align with changes in COGS).

Employee Numbers

  • Understanding Employee Numbers

    • Number of employees typically isn't detailed in financial statements but may be provided in supplementary notes.

Financial Conditions Context

  • Contextual Factors

    • Economic conditions affecting demand (e.g., rising home constructions).

    • External events (like natural disasters) can also create opportunities for industries related to rebuilding (e.g., carpet sales).

Calculation Techniques

  • Percentage Changes

    • For calculating percentage increase in sales:

      • Formula: ((New Value - Old Value) / Old Value) * 100

      • Example: For a jump from $16,400 to $19,300, the percentage change = ((19,300 - 16,400) / 16,400) * 100.

Ratio Analysis Process

  • Steps:

    1. Identify users and their information needs.

    2. Calculate ratios using appropriate data from financial statements.

    3. Interpret and evaluate results for decision-making.

Operational Understanding

  • Exploring Business Model

    • Analysis of expenses (e.g., wages, advertising) will provide insights into business performance beyond just numbers.

Asset and Liabilities**:

  • Balance Sheet Insights

    • Look at non-current and current assets.

    • Any changes here can indicate shifting between liquid assets and liabilities (e.g., bank overdraft).

Profitability Ratios'

  • Importance

    • These ratios assess income generation effectiveness and are crucial for understanding operational profitability.

    • Ratios provide insights over a specified period to gauge management effectiveness and operational efficiency.

  • Efficiency in Finances

    • Evaluate average accounts receivable turnover to assess how effectively resources are managed.

    • Accounts payable timelines matter too; understanding this can inform cash flow management practices.