Post-graduate student Skomarovskaya K, Yerysh L.

Donetsk national university of economics and trade

named after M. Tugan-Baranovsky, Ukraine

Key financial ratios are important stage of the business analyses

Business analyses can be performed by calculating fi­nancial ratios, interpreting those ratios, and by utilizing other techniques such a horizontal analysis and common-size financial statements. Financial statement analysis and its tools and tech­niques provide messages that are not revealed simply by reading the financial statements.

Financial ratios are an excellent way to fully understand the fi­nancial strengths and weaknesses of a company. When analyzing a loan request, credit analysts at a bank will “run” financial ratios and compare them to industry standards. The same is true for in­vestment analysts who perform fundamental analysis before rec­ommending a stock to investors. Fundamental analysis involves analyzing its financial statements, its management and competi­tive advantages, and its competitors and markets.

Financial statements are the raw material of financial analysis. Profitability, liquidity, debt burden, and efficiency and effective­ness can be revealed through ratio analysis. Ratios show financial relationships and important concepts of risk and return that are of great interest to creditors, investors, and management. This chap­ter covers some of the basic analytical concepts that help provide the more complete picture so that well-informed decisions can be made. However, the lessons of financial analysis should include a cautionary note: there are limitations to ratio analysis, horizontal, and vertical (common-size) analysis.

Financial ratios are tools to help you interpret the numbers found in financial statements. Ratios, which show financial relationships by dividing one financial item by another, help to answer critical questions, such as whether the business is carrying excess debt or inventory, whether customers are paying according to terms, whether the operating expenses are too high, and whether the company assets are being used properly to generate income. Po­tential and current investors and security analysts use ratios to de­termine the financial strengths of a company. The banker or credit analyst uses financial ratios to estimate creditworthiness. Ratios are also important tools for management. All functional areas of a company can benefit from ratios. They have strategic value; ratios are a diagnostic tool that tells management whether they are prop­erly executing their plan. In that way, ratios can help not only planning but control.

There are four key areas addressed by financial ratios:

·       profitability

·       utilization of assets

·       liquidity

·       debt burden

When computing financial ratios and analyzing them against benchmarks and in light of trends, a company’s financial strengths and weaknesses become clear. Examining these ratios over time provides some insight as to how effectively the business is being operated.

How much profit is enough? To measure the ability of a company to earn a profit and an adequate return on sales, assets, and in­vested capital, profitability ratios must be calculated. An important grouping of ratios, profit ability ratios are financial metrics that de­termine a business’s ability to generate earnings and effective em­ployment of resources.

Asset utilization ratios are used to determine how well a company is managing its assets. Speed and time are important aspects of utilization ratios. How fast we can collect bills and sell inventory are part of the focus.

Liquidity ratios give financial statement users a glimpse at a com­pany's ability to pay off short-term obligations as they come due. A company’s ability to convert short-term assets into cash to cover debts is of great importance to creditors who are seeking payment.

Since cash and cash flow are the lifeblood of a business, li­quidity ratios are used to determine whether a company will be able to continue as a going concern. The higher the value of a liquidity ratio, the larger the margin of safety that the company possesses to cover short-term debts.

The debt ratio focuses on the use of debt to finance the company, and therefore puts an emphasis on the capital structure and gives some insight into issues related to long-term risk man­agement. It shows financial statement users and management how much debt the company is using and how well that debt is managed.

Financial ratios users also like to work with data that expresses relationships within a single accounting period. This type of anal­ysis, which is commonly referred to as vertical analysis, involves preparing common-size financial statements.

The main advantages of analyzing a financial statement in this manner are that the financial statements of businesses of all sizes can easily be compared. It also makes it easy to see relative annual changes in one business.

 

The literature:

1. Gulia de Nunno, Bernt Oksendal. Advanced mathematical methods for finance, Springer, 2011

2. Moorad Choudhry, Gino Layunt. The future of finance: a new model for banking and investment, Wiley, 2010

3. Robert Alan Hill. Portfolio theory and financial analyses, Robert Alan Hill and Ventus Publishing ApS, 2010

4. Timothy J. Biehler. The mathematics of money: math of business and personal finance decisions, The McGraw-Hill Companies, 2008