Tuesday, December 27, 2011

finanacial ratio

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Analysts use financial ratios to help learn about the firm¡¯s profitability, growth and resource needs. Through this analysis, we detect and understand relationships among various financial statement items. These relationships will provide clues about the outlook for the business. We will use these clues to develop the forecasts needed in our valuation work. Analysts use operating ratios to understand elements of a company¡¯s business, such as profitability and capital efficiency. Operating ratios include revenue growth rate, gross margin percentage, operating margin percentage, effective income tax rate, days receivables outstanding, days payables outstanding, and inventory turnover. Understanding these elements of the business will help us forecast earnings and cash flows.Credit analysts use credit ratios to assess the ability of potential borrowers to repay obligations on a timely basis. This information helps them decide whether to extend credit. Examples of credit ratios are the current ratio, the quick ratio, the debt to capital ratio, and the interest coverage ratio.

Investors and managers use investment ratios to measure a firm¡¯s total performance and, along with the operating ratios, to screen potential investments. Many of these ratios combine information from the income statement and the balance sheet. Some combine financing and operating data to view a net result, while others focus only on the operations. Some measure stock valuation relative to earnings. Examples of investment ratios are the price-to-earnings ratio, the market-to-book ratio, the return on capital, and the return on common equity.

The supervisor should explain to John that these are not the only ratios that affect credit risk. A business¡¯ ability to repay obligations will depend on its general health, its cash generating abilities and its existing credit commitments. To understand a business¡¯ general health and cash generating ability, the credit analyst looks at the operating ratios. There are also factors beyond ratios that are important, including the ability of management and the strength of the companys strategies. Gross margin percentage is gross margin divided by revenues (where gross margin is revenues less cost of goods sold). A key performance measure represents the amount per dollar of revenues that is available to pay other costs after the costs of the product sold have been met. Companies often analyze gross margin percentage when making pricing decisions

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