Specifically, it enables a financial analyst to spot trends in a business and to compare it with the performance of similar business enterprises within the same industry. Financial ratios are grouped into three categories, each showing a different aspect of a company's financial operations. These are profitability ratios, financial leverage ratios and liquidity/solvency ratios.
Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred. The gross profit margin ratio tells us the profit a business makes on its cost of sales, or cost of goods sold. It tells us how much gross profit per peso of turnover our business is earning. Gross profit is the profit we earn before we take off any administration costs, selling costs and so on. The computed operating profit margin, which is the ratio of operating income to sales measures as a percentage of sales, the excess revenue from sales over cost of normal operation excluding financing. Net profit margin, on the other hand, is the ratio of net income to sales. Unlike the operating profit margin, it takes into account the secondary or incidental gains aside from the company's main business operation and all the costs incurred including financing. Return on assets and return on equity are variants of return on investment, which are more significant ratios than the margins. While return on assets measures the rate of return on the total investments of the company, the return on equity assesses the rate of return on the investments of common stockholders in the company (Analyzing Company Reports 2005). Logically, higher profitability ratios indicate a healthier financial condition.
It can be seen that at the end of March 2005 the company does not perform well in terms of profitability. Gross profit margin is 21% of the total turnover while the company's operating profit is 13% of its revenue. However, the company was not able to manage its costs to cover all its expenses outside of its major activities. Its operating income was squeezed leaving a loss of 9 million. This loss explains the negative returns on asset and equity as well as net profit margin. The negative return on equity implies that shareholder's in the company earned a "negative return" on their investments. The company's earning per share is 22% though this is attributable to the dividend declared and not on the net income generated (Table 2).
Table 2. Profitability Ratios of EMAP PLC (2005)
Financial Leverage Ratios
Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm's profits as well as the firm's operating capability to meet its obligation.
Four common ratios are utilized in assessing the leverage of a business entity. Debt to assets ratio is computed as the quotient of total debt and total assets. It measures the extent to which borrowed funds have been employed to finance the firms operations. Meanwhile, debt to equity ratio shows the relationship between the financing provided by creditors against the stockholders. Another measure is the long-term debt to equity ra