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Ratio Analysis Author: Collins QianMarch 1998AgendaUsing ratiosTypes of key ratiosprofitabilityturnoverleverageliquiditycoverageReturn on EquityRatio exercisesForecasting exerciseAbbreviationsKey takeaways Analyzing RatiosRatios in isolation are meaningless. A companys ratios must be examined over time and/or against its competitors’ ratios.Historical comparisonCompetitive comparisonCompare present ratios with same companys historical ratiosIn stable situations, historical ratios may be used to project future performanceCompare a company’s ratios with similar firms’ ratios or with industry averages at the same point in timeLook for trendsLook at relative performance The Art of Ratio AnalysisRatio analysis is an art as well as a science.Which ratios are most important in a given situation?What items should be included/excluded in calculating the ratios?How much influence does management have over the ratios?What do the ratios say about the firm’s strategy? The Need for JudgmentRatio analysis requires keen judgment.Potential ProblemImplicationsManagement can substantially influence financials in the short termNeed to use judgment to understand financialsFinancial statement data is historical, not pro formaNeed to understand that history does NOT necessarily predict futureCross-company comparisons are meaningless if adjustments are not made for different accounting conventionsNeed to standardize across companies to adjust for different accounting methodsThe timing of the reporting period influences funds flows and requirementsNeed to be very sensitive about industry-specific seasonality and cyclicality AgendaUsing ratiosTypes of key ratiosprofitabilityturnoverleverageliquiditycoverageReturn on EquityRatio exercisesForecasting exerciseAbbreviationsKey takeaways Types of RatiosRatios help us understand how well a company is performing. Specifically, how much return is it generating with what level of risk?ReturnRiskProfitabilityOperating marginROSGross margin