Important Financial Ratios – Turnaround Quick Hit

Financial ratios are used to compare different aspects of a company's financial performance. They are used to measure a company's liquidity, profitability, efficiency, and solvency. Ratios are generated from the financial statements, those being:

· Balance Sheet: A balance sheet is a financial statement that summarizes a company’s assets, liabilities, and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders.

· Income Statement: An income statement is a financial statement that reports a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities.

· Statement of Cash Flows: A statement of cash flows is a financial statement that provides a summary of the cash inflows and outflows for a business over a specific accounting period. It is used to assess the liquidity, solvency, and financial stability of a company.

The most important financial ratios are the liquidity ratios. These ratios measure a company's ability to pay short-term obligations. The two most commonly used liquidity ratios are the current ratio and the quick ratio. The current ratio is calculated by dividing a company's current assets by its current liabilities. The quick ratio is calculated by dividing a company's liquid assets (cash, marketable securities, accounts receivable) by its current liabilities.

Profitability ratios measure a company's ability to generate profits. The most common profitability ratios are the gross profit margin, operating profit margin, and net profit margin. The gross profit margin is calculated by dividing a company's gross profits by its total revenues. The operating profit margin is calculated by dividing a company's operating income by its total revenues. The net profit margin is calculated by dividing a company's net income by its total revenues.

Efficiency ratios measure a company's ability to manage its resources. The two most used efficiency ratios are the inventory turnover ratio and the accounts receivable turnover ratio. The inventory turnover ratio is calculated by dividing a company's cost of goods sold by its average inventory. The accounts receivable turnover ratio is calculated by dividing a company's net sales by its average accounts receivable.

Finally, solvency ratios measure a company's ability to meet its long-term financial obligations. The most commonly used solvency ratio is the debt-to-equity ratio. This ratio is calculated by dividing a company's total liabilities by its total equity.

Financial ratios are important tools for investors, lenders, and managers to evaluate a company's financial performance. By using financial ratios, investors and lenders can determine if a company is a good investment or loan prospect, and managers can use them to identify areas in need of improvement.