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What Is Ratio Analysis?

• What Does It Tell You?
• Application

The Bottom Line

• Corporate Finance
• Financial Ratios

Financial Ratio Analysis: Definition, Types, Examples, and How to Use

Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is a cornerstone of fundamental equity analysis .

Key Takeaways

• Ratio analysis compares line-item data from a company's financial statements to reveal insights regarding profitability, liquidity, operational efficiency, and solvency.
• Ratio analysis can mark how a company is performing over time, while comparing a company to another within the same industry or sector.
• Ratio analysis may also be required by external parties that set benchmarks often tied to risk.
• While ratios offer useful insight into a company, they should be paired with other metrics, to obtain a broader picture of a company's financial health.
• Examples of ratio analysis include current ratio, gross profit margin ratio, inventory turnover ratio.

Investopedia / Theresa Chiechi

What Does Ratio Analysis Tell You?

Investors and analysts employ ratio analysis to evaluate the financial health of companies by scrutinizing past and current financial statements. Comparative data can demonstrate how a company is performing over time and can be used to estimate likely future performance. This data can also compare a company's financial standing with industry averages while measuring how a company stacks up against others within the same sector.

Investors can use ratio analysis easily, and every figure needed to calculate the ratios is found on a company's financial statements.

Ratios are comparison points for companies. They evaluate stocks within an industry. Likewise, they measure a company today against its historical numbers. In most cases, it is also important to understand the variables driving ratios as management has the flexibility to, at times, alter its strategy to make it's stock and company ratios more attractive. Generally, ratios are typically not used in isolation but rather in combination with other ratios. Having a good idea of the ratios in each of the four previously mentioned categories will give you a comprehensive view of the company from different angles and help you spot potential red flags.

A ratio is the relation between two amounts showing the number of times one value contains or is contained within the other.

Types of Ratio Analysis

The various kinds of financial ratios available may be broadly grouped into the following six silos, based on the sets of data they provide:

1. Liquidity Ratios

Liquidity ratios measure a company's ability to pay off its short-term debts as they become due, using the company's current or quick assets. Liquidity ratios include the current ratio, quick ratio, and working capital ratio.

2. Solvency Ratios

Also called financial leverage ratios, solvency ratios compare a company's debt levels with its assets, equity, and earnings, to evaluate the likelihood of a company staying afloat over the long haul, by paying off its long-term debt as well as the interest on its debt. Examples of solvency ratios include: debt-equity ratios, debt-assets ratios, and interest coverage ratios.

3. Profitability Ratios

These ratios convey how well a company can generate profits from its operations. Profit margin, return on assets, return on equity, return on capital employed, and gross margin ratios are all examples of profitability ratios .

4. Efficiency Ratios

Also called activity ratios, efficiency ratios evaluate how efficiently a company uses its assets and liabilities to generate sales and maximize profits. Key efficiency ratios include: turnover ratio, inventory turnover, and days' sales in inventory.

5. Coverage Ratios

Coverage ratios measure a company's ability to make the interest payments and other obligations associated with its debts. Examples include the times interest earned ratio and the debt-service coverage ratio .

6. Market Prospect Ratios

These are the most commonly used ratios in fundamental analysis. They include dividend yield , P/E ratio , earnings per share (EPS), and dividend payout ratio . Investors use these metrics to predict earnings and future performance.

For example, if the average P/E ratio of all companies in the S&P 500 index is 20, and the majority of companies have P/Es between 15 and 25, a stock with a P/E ratio of seven would be considered undervalued. In contrast, one with a P/E ratio of 50 would be considered overvalued. The former may trend upwards in the future, while the latter may trend downwards until each aligns with its intrinsic value.

Most ratio analysis is only used for internal decision making. Though some benchmarks are set externally (discussed below), ratio analysis is often not a required aspect of budgeting or planning.

Application of Ratio Analysis

The fundamental basis of ratio analysis is to compare multiple figures and derive a calculated value. By itself, that value may hold little to no value. Instead, ratio analysis must often be applied to a comparable to determine whether or a company's financial health is strong, weak, improving, or deteriorating.

Ratio Analysis Over Time

A company can perform ratio analysis over time to get a better understanding of the trajectory of its company. Instead of being focused on where it is today, the company is more interested n how the company has performed over time, what changes have worked, and what risks still exist looking to the future. Performing ratio analysis is a central part in forming long-term decisions and strategic planning .

To perform ratio analysis over time, a company selects a single financial ratio, then calculates that ratio on a fixed cadence (i.e. calculating its quick ratio every month). Be mindful of seasonality and how temporarily fluctuations in account balances may impact month-over-month ratio calculations. Then, a company analyzes how the ratio has changed over time (whether it is improving, the rate at which it is changing, and whether the company wanted the ratio to change over time).

Ratio Analysis Across Companies

Imagine a company with a 10% gross profit margin. A company may be thrilled with this financial ratio until it learns that every competitor is achieving a gross profit margin of 25%. Ratio analysis is incredibly useful for a company to better stand how its performance compares to similar companies.

To correctly implement ratio analysis to compare different companies, consider only analyzing similar companies within the same industry . In addition, be mindful how different capital structures and company sizes may impact a company's ability to be efficient. In addition, consider how companies with varying product lines (i.e. some technology companies may offer products as well as services, two different product lines with varying impacts to ratio analysis).

Different industries simply have different ratio expectations. A debt-equity ratio that might be normal for a utility company that can obtain low-cost debt might be deemed unsustainably high for a technology company that relies more heavily on private investor funding.

Ratio Analysis Against Benchmarks

Companies may set internal targets for their financial ratios. These calculations may hold current levels steady or strive for operational growth. For example, a company's existing current ratio may be 1.1; if the company wants to become more liquid, it may set the internal target of having a current ratio of 1.2 by the end of the fiscal year.

Benchmarks are also frequently implemented by external parties such lenders. Lending institutions often set requirements for financial health as part of covenants in loan documents. Covenants form part of the loan's terms and conditions and companies must maintain certain metrics or the loan may be recalled.

If these benchmarks are not met, an entire loan may be callable or a company may be faced with an adjusted higher rate of interest to compensation for this risk. An example of a benchmark set by a lender is often the debt service coverage ratio which measures a company's cash flow against it's debt balances.

Examples of Ratio Analysis in Use

Ratio analysis can predict a company's future performance — for better or worse. Successful companies generally boast solid ratios in all areas, where any sudden hint of weakness in one area may spark a significant stock sell-off. Let's look at a few simple examples

Net profit margin , often referred to simply as profit margin or the bottom line, is a ratio that investors use to compare the profitability of companies within the same sector. It's calculated by dividing a company's net income by its revenues. Instead of dissecting financial statements to compare how profitable companies are, an investor can use this ratio instead. For example, suppose company ABC and company DEF are in the same sector with profit margins of 50% and 10%, respectively. An investor can easily compare the two companies and conclude that ABC converted 50% of its revenues into profits, while DEF only converted 10%.

Using the companies from the above example, suppose ABC has a P/E ratio of 100, while DEF has a P/E ratio of 10. An average investor concludes that investors are willing to pay $100 per $1 of earnings ABC generates and only $10 per $1 of earnings DEF generates.

What Are the Types of Ratio Analysis?

Financial ratio analysis is often broken into six different types: profitability, solvency, liquidity, turnover, coverage, and market prospects ratios. Other non-financial metrics may be scattered across various departments and industries. For example, a marketing department may use a conversion click ratio to analyze customer capture.

What Are the Uses of Ratio Analysis?

Ratio analysis serves three main uses. First, ratio analysis can be performed to track changes to a company over time to better understand the trajectory of operations. Second, ratio analysis can be performed to compare results with other similar companies to see how the company is doing compared to competitors. Third, ratio analysis can be performed to strive for specific internally-set or externally-set benchmarks.

Why Is Ratio Analysis Important?

Ratio analysis is important because it may portray a more accurate representation of the state of operations for a company. Consider a company that made $1 billion of revenue last quarter. Though this seems ideal, the company might have had a negative gross profit margin, a decrease in liquidity ratio metrics, and lower earnings compared to equity than in prior periods. Static numbers on their own may not fully explain how a company is performing.

What Is an Example of Ratio Analysis?

Consider the inventory turnover ratio that measures how quickly a company converts inventory to a sale. A company can track its inventory turnover over a full calendar year to see how quickly it converted goods to cash each month. Then, a company can explore the reasons certain months lagged or why certain months exceeded expectations.

There is often an overwhelming amount of data and information useful for a company to make decisions. To make better use of their information, a company may compare several numbers together. This process called ratio analysis allows a company to gain better insights to how it is performing over time, against competition, and against internal goals. Ratio analysis is usually rooted heavily with financial metrics, though ratio analysis can be performed with non-financial data.

• Valuing a Company: Business Valuation Defined With 6 Methods 1 of 37
• What Is Valuation? 2 of 37
• Valuation Analysis: Meaning, Examples and Use Cases 3 of 37
• Financial Statements: List of Types and How to Read Them 4 of 37
• Balance Sheet: Explanation, Components, and Examples 5 of 37
• Cash Flow Statement: How to Read and Understand It 6 of 37
• 6 Basic Financial Ratios and What They Reveal 7 of 37
• 5 Must-Have Metrics for Value Investors 8 of 37
• Earnings Per Share (EPS): What It Means and How to Calculate It 9 of 37
• P/E Ratio Definition: Price-to-Earnings Ratio Formula and Examples 10 of 37
• Price-to-Book (PB) Ratio: Meaning, Formula, and Example 11 of 37
• Price/Earnings-to-Growth (PEG) Ratio: What It Is and the Formula 12 of 37
• Fundamental Analysis: Principles, Types, and How to Use It 13 of 37
• Absolute Value: Definition, Calculation Methods, Example 14 of 37
• Relative Valuation Model: Definition, Steps, and Types of Models 15 of 37
• Intrinsic Value of a Stock: What It Is and Formulas to Calculate It 16 of 37
• Intrinsic Value vs. Current Market Value: What's the Difference? 17 of 37
• The Comparables Approach to Equity Valuation 18 of 37
• The 4 Basic Elements of Stock Value 19 of 37
• How to Become Your Own Stock Analyst 20 of 37
• Due Diligence in 10 Easy Steps 21 of 37
• Determining the Value of a Preferred Stock 22 of 37
• Qualitative Analysis 23 of 37
• How to Choose the Best Stock Valuation Method 24 of 37
• Bottom-Up Investing: Definition, Example, Vs. Top-Down 25 of 37
• Financial Ratio Analysis: Definition, Types, Examples, and How to Use 26 of 37
• What Book Value Means to Investors 27 of 37
• Liquidation Value: Definition, What's Excluded, and Example 28 of 37
• Market Capitalization: What It Means for Investors 29 of 37
• Discounted Cash Flow (DCF) Explained With Formula and Examples 30 of 37
• Enterprise Value (EV) Formula and What It Means 31 of 37
• How to Use Enterprise Value to Compare Companies 32 of 37
• How to Analyze Corporate Profit Margins 33 of 37
• Return on Equity (ROE) Calculation and What It Means 34 of 37
• Decoding DuPont Analysis 35 of 37
• How to Value Private Companies 36 of 37
• Valuing Startup Ventures 37 of 37

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Financial Ratio Analysis Tutorial With Examples

The Balance Sheet for Financial Ratio Analysis

The income statement for financial ratio analysis, analyzing the liquidity ratios, the current ratio, the quick ratio, analyzing the asset management ratios accounts receivable, receivables turnover, average collection period, inventory, fixed assets, total assets, inventory turnover ratio, fixed asset turnover, total asset turnover, analyzing the debt management ratios, debt-to-asset ratio, times interest earned ratio, fixed charge coverage, analyzing the profitability ratios, net profit margin, return on assets, return on equity, financial ratio analysis of xyz corporation.

While it may be more fun to work on marketing efforts, the financial management of a firm is a crucial aspect of owning a business. Financial ratios help break down complex financial information into key details and relationships. Financial ratio analysis involves studying these ratios to learn about the company's financial health.

Here are a few of the most important financial ratios for business owners to learn, what they tell you about the company's financial statements , and how to use them.

Key Takeaways

• Some of the most important financial ratios for business owners include the current ratio, the inventory turnover ratio, and the debt-to-asset ratio.
• These financial ratios quickly break down the complex information from financial statements.
• Financial ratios are snapshots, so it's important to compare the information to previous periods of data as well as competitors in the industry.

Here is the balance sheet we are going to use for our financial ratio tutorial. You will notice there are two years of data for this company so we can do a time-series (or trend) analysis and see how the firm is doing across time.

Here is the complete income statement for the firm for which we are doing financial ratio analysis. We are doing two years of financial ratio analysis for the firm so we can compare them.

Refer back to the income statement and balance sheet as you work through the tutorial.

The first ratios to use to start getting a financial picture of your firm measure your liquidity, or your ability to convert your current assets to cash quickly. They are two of the 13 ratios. Let's look at the current ratio and the quick (acid-test) ratio .

The current ratio measures how many times you can cover your current liabilities. The quick ratio measures how many times you can cover your current liabilities without selling any inventory and so is a more stringent measure of liquidity.

Remember that we are doing a time series analysis, so we will be calculating the ratios for each year.

Current Ratio : For 2020, take the Total Current Assets and divide them by the Total Current Liabilities. You will have: Current Ratio = 642/543 = 1.18X. This means that the company can pay for its current liabilities 1.18 times over. Practice calculating the current ratio for 2021.

Your answer for 2021 should be 1.31X. A quick analysis of the current ratio will tell you that the company's liquidity has gotten just a little bit better between 2020 and 2021 since it rose from 1.18X to 1.31X.

Quick Ratio : In order to calculate the quick ratio, take the Total Current Ratio for 2020 and subtract out Inventory. Divide the result by Total Current Liabilities. You will have: Quick Ratio = (642-393)/543 = 0.46X. For 2021, the answer is 0.52X.

Like the current ratio, the quick ratio is rising and is a little better in 2021 than in 2020. The firm's liquidity is getting a little better. The problem for this company, however, is that they have to sell inventory in order to pay their short-term liabilities and that is not a good position for any firm to be in. This is true in both 2020 and 2021.

This firm has two sources of current liabilities: accounts payable and notes payable. They have bills that they owe to their suppliers (accounts payable) plus they apparently have a bank loan or a loan from some alternative source of financing. We don't know how often they have to make a payment on the note.

Asset management ratios are the next group of financial ratios that should be analyzed. They tell the business owner how efficiently they employ their assets to generate sales. Assume all sales are on credit.

• Receivables Turnover = Credit Sales/Accounts Receivable = ___ X so:
• Receivables Turnover = 2,311/165 = 14X

A receivables turnover of 14X in 2020 means that all accounts receivable are cleaned up (paid off) 14 times during the 2020 year. For 2021, the receivables turnover is 15.28X. Look at 2020 and 2021 Sales in The Income Statement and Accounts Receivable in The Balance Sheet.

The receivables turnover is rising from 2020 to 2021. We can't tell if this is good or bad. We would really need to know what type of industry this firm is in and get some industry data to compare to.

Customers paying off receivables is, of course, good. But, if the receivables turnover is way above the industry's, then the firm's credit policy may be too restrictive.

Average collection period is also about accounts receivable. It is the number of days, on average, that it takes a firm's customers to pay their credit accounts. Together with receivables turnover, average collection helps the firm develop its credit and collections policy.

• Average Collection Period = Accounts Receivable/Average Daily Credit Sales*
• *To arrive at average daily credit sales, take credit sales and divide by 360
• Average Collection Period = $165/2311/360 = $165/6.42 = 25.7 days
• In 2021, the average collection period is 23.5 days

From 2020 to 2021, the average collection period is dropping. In other words, customers are paying their bills more quickly. Compare that to the receivables turnover ratio. Receivables turnover is rising and the average collection period is falling.

This makes sense because customers are paying their bills faster. The company needs to compare these two ratios to industry averages. In addition, the company should take a look at its credit and collections policy to be sure they are not too restrictive. Take a look at the image above and you can see where the numbers came from on the balance sheets and income statements.

Along with the accounts receivable ratios that we analyzed above, we also have to analyze how efficiently we generate sales with our other assets: inventory, plant and equipment, and our total asset base.

The inventory turnover ratio is one of the most important ratios a business owner can calculate and analyze. If your business sells products as opposed to services, then inventory is an important part of your equation for success.

Inventory Turnover = Sales/Inventory = ______ X

If your inventory turnover is rising, that means you are selling your products faster. If it is falling, you are in danger of holding obsolete inventory. A business owner has to find the optimal inventory turnover ratio where the ratio is not too high and there are no stockouts or too low where there is obsolete money. Both are costly to the firm.

For this company, their inventory turnover ratio for 2020 is:

Inventory Turnover Ratio = Sales/Inventory = 2311/393 = 5.9X

This means that this company completely sells and replaces its inventory 5.9 times every year. In 2021, the inventory turnover ratio is 6.8X. The firm's inventory turnover is rising. This is good in that they are selling more products. The business owner should compare the inventory turnover with the inventory turnover ratio with other firms in the same industry.

The fixed asset turnover ratio analyzes how well a business uses its plant and equipment to generate sales. A business firm does not want to have either too little or too much plant and equipment. For this firm for 2020:

Fixed Asset Turnover = Sales/Fixed Assets = 2311/2731 = 0.85X

For 2021, the fixed asset turnover is 1.00. The fixed asset turnover ratio is dragging down this company. They are not using their plant and equipment efficiently to generate sales as, in both years, fixed asset turnover is very low.

The total asset turnover ratio sums up all the other asset management ratios. If there are problems with any of the other total assets, it will show up here, in the total asset turnover ratio.

Total Asset Turnover = Sales/Total Asset Turnover = Sales/Total Assets = 2311/3373 = 0.69X for 2020. For 2021, the total asset turnover is 0.80. The total asset turnover ratio is somewhat concerning since it was not even 1X for either year.

This means that it was not very efficient. In other words, the total asset base was not very efficient in generating sales for this firm in 2020 or 2021. Why?

It seems to me that most of the problem lies in the firm's fixed assets. They have too much plant and equipment for their level of sales. They either need to find a way to increase their sales or sell off some of their plant and equipment. The fixed asset turnover ratio is dragging down the total asset turnover ratio and the firm's asset management in general.

There are three debt management ratios that help a business owner evaluate the company in light of its asset base and earning power. Those ratios are the debt-to-asset ratio, the times interest earned ratio , and the fixed charge coverage ratios. Other debt management ratios exist, but these help give business owners the first look at the debt position of the company and the prudence of that debt position.

The first debt ratio that is important for the business owner to understand is the debt-to-asset ratio ; in other words, how much of the total asset base of the firm is financed using debt financing. For example. the debt-to-asset ratio for 2020 is:

Total Liabilities/Total Assets = $1074/3373 = 31.8%. This means that 31.8% of the firm's assets are financed with debt. In 2021, the debt ratio is 27.8%. In 2021, the business is using more equity financing than debt financing to operate the company.

We don't know if this is good or bad since we do not know the debt-to-asset ratio for firms in this company's industry. However, we do know that the company has a problem with its fixed asset ratio which may be affecting the debt-to-asset ratio.

The times interest earned ratio tells a company how many times over a firm can pay the interest that it owes. Usually, the more times a firm can pay its interest expense the better. The times interest earned ratio for this firm for 2020 is:

• Times Interest Earned = Earnings Before Interest and Taxes/Interest = 276/141 = 1.96X
• For 2021, the times interest earned ratio is 3.35

The times interest earned ratio is very low in 2020 but better in 2021. This is because the debt-to-asset ratio dropped in 2021.

The fixed charge coverage ratio is very helpful for any company that has any fixed expenses they have to pay. One fixed charge (expense) is interest payments on debt, but that is covered by the times interest earned ratio.

Another fixed charge would be lease payments if the company leases any equipment, a building, land, or anything of that nature. Larger companies have other fixed charges which can be taken into account.

• Fixed charge coverage = Earnings Before Fixed Charges and Taxes/Fixed Charges = _____X

In both 2020 and 2021 for the company in our example, its only fixed charge is interest payments. So, the fixed charge coverage ratio and the times interest earned ratio would be exactly the same for each year for each ratio.

The last group of financial ratios that business owners usually tackle are the profitability ratios as they are the summary ratios of the 13 ratio group. They tell the business firm how they are doing on cost control, efficient use of assets, and debt management, which are three crucial areas of the business.

The net profit margin measures how much each dollar of sales contributes to profit and how much is used to pay expenses. For example, if a company has a net profit margin of 5%, this means that 5 cents of every sales dollar it takes in goes to profit and 95 cents goes to expenses. For 2020, here is XYZ, Inc's net profit margin:

Net Profit Margin = Net Income/Sales Revenue = 89.1/2311 = 3.9%

For 2021, the net profit margin is 6.5%, so there was quite an increase in their net profit margin. You can see that their sales took quite a jump but their cost of goods sold rose. It is the best of both worlds when sales rise and costs fall. Bear in mind, the company can still have problems even if this is the case.

The return on assets ratio, also called return on investment , relates to the firm's asset base and what kind of return they are getting on their investment in their assets. Look at the total asset turnover ratio and the return on asset ratio together. If total asset turnover is low, the return on assets is going to be low because the company is not efficiently using its assets.

Another way to look at the return on assets is in the context of the Dupont method of financial analysis. This method of analysis shows you how to look at the return on assets in the context of both the net profit margin and the total asset turnover ratio.

• To calculate the Return on Assets ratio for XYZ, Inc. for 2020, here's the formula:
• Return on Assets = Net Income/Total Assets = 2.6%

For 2021, the ROA is 5.2%. The increased return on assets in 2021 reflects the increased sales and much higher net income for that year.

The return on equity ratio is the one of most interest to the shareholders or investors in the firm. This ratio tells the business owner and the investors how much income per dollar of their investment the business is earning. This ratio can also be analyzed by using the Dupont method of financial ratio analysis. The company's return on equity for 2020 was:

Return on Equity = Net Income/Shareholder's Equity = 3.9%

For 2021, the return on equity was 7.2%. One reason for the increased return on equity was the increase in net income. When analyzing the return on equity ratio, the business owner also has to take into consideration how much of the firm is financed using debt and how much of the firm is financed using equity.

Now we have a summary of all 13 financial ratios for XYZ Corporation. The first thing that jumps out is the low liquidity of the company. We can look at the current and quick ratios for 2020 and 2021 and see that the liquidity is slightly increasing between 2020 and 2021, but it is still very low.

By looking at the quick ratio for both years, we can see that this company has to sell inventory in order to pay off short-term debt. The company does have short-term debt: accounts payable and notes payable, and we don't know when the notes payable will come due.

Let's move on to the asset management ratios. We can see that the firm's credit and collections policies might be a little restrictive by looking at the high receivable turnover and low average collection period. Customers must pay this company rapidly—perhaps too rapidly. There is nothing particularly remarkable about the inventory turnover ratio, but the fixed asset turnover ratio is remarkable.

The fixed asset turnover ratio measures the company's ability to generate sales from its fixed assets or plant and equipment. This ratio is very low for both 2020 and 2021. This means that XYZ has a lot of plant and equipment that is unproductive.

It is not being used efficiently to generate sales for the company. In addition, the company has to service the plant and equipment, pay for breakdowns, and perhaps pay interest on loans to buy it through long-term debt.

It seems that a very low fixed asset turnover ratio might be a major source of problems for XYZ. The company should sell some of this unproductive plant and equipment, keeping only what is absolutely necessary to produce their product.

The low fixed asset turnover ratio is dragging down total asset turnover. If you follow this analysis on through, you will see that it is also substantially lowering this firm's return on assets profitability ratio.

With this firm, it is hard to analyze the company's debt management ratios without industry data. We don't know if XYZ is a manufacturing firm or a different type of firm.

As a result, analyzing the debt-to-asset ratio is difficult. What we can see, however, is that the company is financed more with shareholder funds (equity) than it is with debt as the debt-to-asset ratio for both years is under 50% and dropping.

This fact means that the return on equity profitability ratio will be lower than if the firm was financed more with debt than with equity. On the other hand, the risk of bankruptcy will also be lower.

Unfortunately, you can see from the times interest earned ratio that the company does not have enough liquidity to be comfortable servicing its debt. The company's costs are high and liquidity is low. Fortunately, the company's net profit margin is increasing because their sales are increasing.

Hopefully, this is a trend that will continue. Return on Assets is impacted negatively due to the low fixed asset turnover ratio and, to some extent, by the receivables ratios. Return on Equity is increasing from 2020 to 2021, which will make investors happy.

As you can see, it is possible to do a cursory financial ratio analysis of a business firm with only 13 financial ratios, even though ratio analysis has inherent limitations.

Wells Fargo. " 5 Ways To Improve Your Liquidity Ratio ."

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.2 Operating Efficiency Ratios ." OpenStax, 2022.

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 2, 4.

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 3, 6.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.4 Solvency Ratios ." OpenStax, 2022.

Nasdaq. " Fixed-Charge Coverage Ratio ."

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 3, 5.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.6 Profitability Ratios and the DuPont Method ." OpenStax, 2022.

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Good Example Of Financial Ratio Analysis Research Paper

Type of paper: Research Paper

Topic: Finance , Ratio , Investment , Ford Motor , Company , Wealth , General Motors , Business

Words: 1700

Published: 01/02/2021

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ANALYSIS OF FORD AND GENERAL MOTORS

Introduction General Motors underwent incorporation as a Delaware corporation in 2009.The company designs builds and sells automobiles and automobile parts world over. Also, the company through GM Financial provides automotive financing services. Similarly, Ford Motor Company sells automobiles created and built by Henry Ford. The company, incorporated in Delaware in 1919, has its operations in six continents. Other than the production and sales of automobiles, it engages in the provision of financial services through Ford Motor Credit Company.

The process involves comparison of financial ratios of General Motors, Ford Company and the averages within the industry of operation. The ratios can be profitability, solvency, gearing, and liquidity (Morley, 1984)

Profitability analysis

Net profit margin Net profit margin indicates the net profit a company earns per dollar of total sales. It is a profitability ratio that is key in comparing two companies in the same industry (Grier, 2007). A high net profit margin indicates a high profitability. In comparing two companies, it is true that the one with a higher net profit margin is more profitable. In the period ending 31st December 2014, General Motors Company had a net profit margin of 2.58% which is a fall from a figure of 3.43% in the period ending 2013. The trend indicates a fall in profitability between 2013 and 2014 for General Motors. Ford’s net profit margin for 2014 was 2.21% meaning that it registered a profit of $0.0221 for every dollar of revenue generated during the year (Grier, 2007). The value represents a decline from 4.89 registered in 2013. The ratio indicates that the profitability of both the companies fell in 2014.In 2013, Ford registered a higher rate of profitability than General Motors. However, the results of 2014 show a different pattern. In comparison to the industry net profit margin of 2.54% posted in the last quarter of 2014, only General Motors is doing better than the industry.

Return on Assets

This ratio measures the ability of the company to use its assets in generating a net profit (Khan & Jain, 2007). It indicates how efficiently the investment in assets recovered in profits. A high Return on Assets means the company is using its assets efficiently. In comparing two firms within the same industry, a higher Return on Assets is an indicator of better performance. General Motors recorded a Return on assets of 2.26% in 2014 which was a fall from a value of 3.20% in 2013 indicating a fall in profitability of the company. The figures imply that a profit of $0.0226 is realizable for every dollar of assets used. Ford Company, on the other hand, registers a Return on Assets of 1.53% indicating a decline from 3.55% registered in the year 2013. The industry registers a Return on assets of 2.76% in 2014 implying that both General Motors and Ford are performing poorer than industry levels.

Return on equity

As a profitability ratio, return on equity is an expression of net income as a percentage of the stockholder’s equity. It signals how much profit the company generates from a dollar of investment (Khan & Jain, 2007). In 2014, General Motors recorded a Return on Equity of 11.33%. The value implies that the organization realized a net income of $0.1133 on every dollar of equity invested. The figure realized is lower than the 12. 51% realized in the financial year 2013. Similarly, Ford registers a fall in its return on investment from 27.55 in 2013 to 12.85% in 2014. Ford has a higher Return on Equity in both years. For both companies, the value registered as the return on equity in 2014 for the industry is higher at 16.47%. Ford Company realizes a higher Return on Equity because they sell to their dealerships for retail sale and for sale to fleet customers (Khan & Jain, 2007). These fleet customers include daily rental car companies and governments. Such sales also involve the sale of accessories and parts.

Liquidity ratios

Current ratio The current ratio indicates the amount of current assets available per dollar of current obligations (Gibson, 2009). A current ratio of more than one implies that a business has sufficient current assets to pay its short-term obligations. As at 31st December 2014, the current ratio for General Motors was 1.27 implying that its current assets were adequate to pay all its current liabilities as soon as they were due. For every dollar of current liabilities, there was $1.27 of current assets. The firm’s current ratio decreased from 1.31 in 2013 signaling that the liquidity of general motors decreased in 2014. Ford’s current ratio was 6.58 showing that its current assets were 658% of the total current liabilities in 2014. Therefore, Ford’s current assets were sufficient to repay all its current obligations. The ratio was 6.74 in 2013. The above trend indicates that the liquidity of Ford declined. Ford had a better liquidity than General Motors in both years. In December, the industry had a debt coverage ratio of 1.32. This value is slightly higher than that of General Motors implying that the firm was doing worse than the industry. Ford, on the other hand, had a current ratio that is higher than that of the industry making it financially healthy

Quick ratio

The quick ratio for general motors was 1.07 in 2014 thus its quick assets could meet all of its total current obligations (Vandyck, 2006). The quick ratio was more than the desired/rule of thumb’s value of 1. The ratio was 1.08 in 2013 implying that the liquidity of general motors decreased in 2014. The quick ratio for Ford was 6.19 in 2014 indicating that its quick assets were 619% of the total value of its current obligations. Therefore, the quick assets were adequate to cover all its short-term obligations (Vandyck, 2006). The ratio decreased from 6.34 in 2013 indicating that Ford’s liquidity worsened in 2014. It had a better liquidity than that of general motors in both years. The industry had a quick ratio of 0.39 signaling that General Motors n good financial health (Gibson, 2009). Similarly, Ford was in a perfect state to deal with obligations that would require quick assets to be settled.

Solvency ratios

These ratios measure the ability of the company to continue by comparing its debt levels with equity assets and earnings. They give the picture of the company's ability to make payments to creditors, bondholders and banks

Debt equity ratio

The debt-to-equity ratio as a financial ratio gives the proportion of debt financing (liabilities) about the organization’s equity (Gibson, 2009). The high debt-to-equity ratio is not favorable as it implies that the business is borrowing more resulting in increased risks such as high-interest rates. If this ratio is more than one, then the implication is that asset financing comes more from debt and less from equity. General Motors recorded a debt-to-equity ratio of 3.995 in 2014. This value is a rise from 2.89 in 2013 implying that for every dollar of equity, the organization had $3.995 of liabilities (Peterson & Fabozzi, 2012). This value had risen within the financial year signaling an increased leverage activity by the organization. Ford had a debt-to-equity ratio of 7.39 in 2014 and 6.73 in 2013. The figures represent an increase in the gearing ratio for the organization (Morley, 1984). The firm now uses a debt financing that is 739% of equity. The reason for such an increase could be partly due to Fords funding strategy that require the organization to maintain a given level of liquidity to support the financing services and growth. Both organizations operated at a ratio that was above the industry rate of 1.31 by December 2014.

Total debt ratio

This ratio gives an indication of the organization’s debts as a percentage of its assets. Being a solvency ratio, it shows the ability of the company to pay off its obligations with its assets. The total debt ratio percentage represent the percentage/ proportion of the total assets that has been financed by debt. The ratio usually ranges between 0.00 and 1. If the value is high, then it implies that the claims of creditors are of a high proportion of the assets. Ford had a total debt ratio of 0.88 in 2014 implying that 88% of the assets are under the claims of creditors. The value represents an increase from 0.87 in 2013 implying that the organization is becoming more leveraged (Peterson & Fabozzi, 2012). General Motors recorded a total debt ratio of 0.7973. The figure represents an increase from 0.7405 in 2013. The increase implies an increase in the level of leverage of the company. The figures are however lower than those within the industry which reported a value of 3.83 as at December 2014. The analysis indicates that Ford was more profitable in 2013 than General Motors, but that changed in 2014. The liquidity of Ford was higher than that of general motors in both years

Gibson, C. (2009). Financial reporting & analysis. Mason, OH: South-Western Cengage Learning. Grier, W. (2007). Credit analysis of financial institutions. [London]: Euromoney. Khan, M., & Jain, P. (2007). Management accounting. New Delhi: Tata McGraw-Hill. Morley, M. (1984). Ratio analysis. Berkshire, England: Published for the Institute of Chartered Accountants of Scotland by Gee & Co. Peterson, P., & Fabozzi, F. (2012). Analysis of Financial Statements. Hoboken: John Wiley & Sons. Vandyck, C. (2006). Financial ratio analysis. Victoria, B.C.: Trafford. APPENDIX GENERAL MOTORS INCOME STATEMENT BALANCE SHEET FORD FORD INCOME STATEMENT

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Ratio Data: Definition, Examples, and Analysis

Published by Owen Ingram at September 2nd, 2021 , Revised On July 20, 2023

There are a total of four types of data in statistics primarily. They are nominal data, ordinal data, ratio data, and interval data.

Ordinal Data : This type of data is classified into categories. However, the distance between these categories is unknown.

Nominal Data : Nominal data is used to label variables without assigning any quantitative value to them.

Ratio Data: This is a kind of qualitative data that measures variables on a continuous scale.

Interval Data : This data type is measured along a scale and has an equal distance between its values.

If you’re looking to learn everything there is to know about the ratio data, then you’re at the right place. Let’s take a look into the definition, examples, and analysis of ratio data.

What is a Ratio Data?

A Ratio scale is the fourth type of measurement scale and is quantitative in nature. It is similar to interval data , where each value is placed at an equal distance from its subsequent value. However, it has a ‘true zero,’ which means that zero possesses a meaning.

The ratio scale contains the characteristics of nominal, ordinal, and interval scales and is, therefore, used widely in market research.

Examples of Ratio Data

Here are some of the common examples of ratio data:

• Mass and Weight

In Market Research, it is used to evaluate:

• Number of customers

Ratio Data vs. Interval Data – The Difference

Both interval and ratio data have equal values placed between two variables . However, one significant difference between the two is the presence of the ‘true zero.’ The ratio data has a true zero, which denotes an absence of a variable. For example, in interval data, you can measure temperature beyond 0 degrees because zero, in this case, holds a value. However, in ratio data, the variables never fall beneath zero.

An example of this is body mass. We know mass is measured from 0 as a starting point and goes above. It does not fall beneath zero.

Characteristics of Ratio Data

Here are some of the characteristics of the ratio data:

• Absolute zero: As explained earlier, ratio scales have an absolute zero. Although they are not categorical, they have a specific order and have equal distance between their values. We can use multiplication or division to describe them because of the absolute zero characteristics in the ratio scales. For example, 40kg is twice more than 20kg, or the distance from point A to B is 50km which is twice less than the distance from point B to C, i.e., 150km.
• No negative number: Because ratio scales have an absolute zero, they do not have significant negative numbers. Unlike interval scales where -10 would hold a meaningful, ratio scales begin from a certain point as a way of measurement.
• Possibilities for statistical measurement: Since ratio scales have an absolute zero, variables in this type of data can be added, subtracted, multiplied, or divided. Furthermore, all measures of central tendency can be performed with ratio scales. These include the mean , mode , and median .

Not sure which statistical tests to use for your data?

Let the experts at researchprospect do the daunting work for you. 📊📈.

Using our approach, we illustrate how to collect data, sample sizes, validity, reliability, credibility, and ethics, so you won’t have to do it all by yourself!

How is Ratio Data Collected?

There are several ways to collect ratio data. Your method solely depends on the type of research you’re doing. Common ways to collect data are surveys, questionnaires, and interviews.

• Interviews: In this method, participants are interviewed ad data is collected from there. Such discussions are often structured, semi-structured, or unstructured. They can be either face-to-face, telephonic, panel or group, and computer-assisted.
• Questionnaires and Surveys: This is a standard data collection method for qualitative data. A survey or a questionnaire is handed out to participants, and they are asked to answer a series of questions. Their answers are then recorded for qualitative analysis.
• Direct Observation: Ratio data can also be collected through direct observation. For example, if you were to measure the height of some athletes, there will be a point zero. A measurement of 0 would indicate an absence of the athlete.
• Automated Data Collectors: Some roads have automated speed calculators, which are an efficient and practical way to collect data.

Here’s an example,

Question: How much is your family’s monthly income?

Possible answers: $0-$5000, $5000-$10,000, $10,000-$15,000, $15,000 or more.

Note: The distance between the intervals is equal, i.e., $5000.There is also a true zero. Also, the answer can not be negative, i.e., $ -20

Analyzing Ratio Data

Ratio Data can be analyzed and interpreted in precisely the same way as the interval way. These include the following methods:

• Mean : This is the average of the interval data set. Mean can be calculated by adding the numbers in the interval data set and dividing this total by the number of values in the set.
• Median : Median is used to determine the middle value in the data set. Since all values in the interval data are equal distance apart, the median is easy to calculate.
• Mode : This is the value that is the most occurring in the data set.
• Standard Deviation: This measures the dispersion of a data set relative to its mean.
• Percentiles: This is the percentage of values that fall below a specific number from the data set. For example, let’s suppose the 75th percentile of an IELTS test is 6.0 overall. If you scored an overall 6.0, this would mean that your score was better than 75% of the IELTS test takers.
• Range : This is the difference between the highest and the lowest value in the data set.

What Statistical Tests can you do with Ratio Data?

You can perform several statistical tests with ratio scales, mainly,

• Pearson Correlation
• Simple Linear Regression

And that’s a wrap! That’s all you need to know about ratio data, its definition, examples, and analysis.

FAQs About Ratio Data

What are the main differences between interval and ratio scales.

• Interval scales do not have a true zero, whereas ratio scales do.
• Negative numbers have meaning in interval scales, whereas negative numbers do not hold any meaningful value in ratio scales.
• Interval data can only be expressed using addition or subtraction, whereas ratio data can be expressed using addition, subtraction, multiplication, and division.

What are the examples of Ratio Scales?

Some common examples of ratio scales are age, distance, speed, and mass. What are the four levels of measurement of data? The four levels of measurement of data are nominal , ordinals , interval , and ratio data.

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Ordinal data, as the name itself suggests, has its variables in a specific hierarchy or order. It is categorical data with a set scale or order to it.

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