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Financial Ratios - Essay Example
Author : freddy87
Pages 7 (1757 words)
One of the time-tested methods in analyzing a business is the use of financial ratios. Big firms and businesses make use of financial ratio analysis to know more about a company's potential and current financial health. Specifically, financial ratios can be used in two different but equally useful ways:
In addition, you can use these ratios to compare the performance of your company against that of your competitors or other members of your industry. (Alex Auerbach)
When you take profit before tax or interest (EBIT) and divide it by the difference between total assets and current liabilities, you can get a financial ratio known as return on capital employed ratio or ROCE. It is a ratio that shows the company's capital investments' profitability and efficiency. The ROCE ratio is a measure of how well a company is using capital to generate income. A high ROCE is a sign or a successful growth company and indicates that a larger mass of proceeds can be reinvested to gain more profit. However; one year ROCE evaluation should not be the basis for reinvesting. Investors should look closely on the trend over several years to have consistency. A sudden decline in ROCE signals a loss of competitive advantage.
Asset Turnover Ratio specifies the connection between assets and revenue (Revenue/Total assets). It gauges a company's efficiency in using its resources in making sales. A higher asset Turnover is better. It also specifies pricing strategy: companies with low profit margins are inclined to have high asset turnover, whereas those with high profit margins tend to have low asset turnover. ...