Financial ratios

The most commonly used technique for considering financial statements is ratio analysis. Financial ratios can be used to evaluate a particular aspect of a customer’s company operations and financial health. However, the challenge facing accountants is the sheer number of types of ratio that can be performed, as well as the reality that no single ratio typically reveals enough information on which to base a sound credit decision.

List of ratios

To evaluate a particular customer’s financial health, the four areas that our Financial Ratios list focuses on are:

Liquidity. This is the overall solvency of the firm. The more “liquid” the firm, the more easily it can meet its short-term obligations as they fall due or convert an asset into cash with little or no loss in value.

Profitability. This accounts for management’s ability to control expenses and earn a return on resources. Expressing each expense item as a percentage of sales allows for easy evaluation of a company’s profitability relative to sales.

Debt levels (gearing). Debt allows for profits to be generated but also creates claims against that profit. Gearing measures the risk and return resulting from the use of fixed-cost financing, such as loans. It also measures the degree of protection of long-term finance suppliers and can aid in judging a firm’s ability to raise additional debt.

Asset turnover. This is the speed with which certain assets can be converted into sales or cash, e.g. stock turnover, debtor days etc.