When comes financial statements of the company then there is a word ratio analysis. Mostly investors can't interpret financial statements without ratios because ratios play key roles in financial world.
Ratio analysis is the most important part for company financial statements analysis along with company. In financial world, there are lots of ratio and most of the retail investors could not be able to interpret all the ratios for analysis financial statements.
However, there are few important ratios that help investors to analyze the financial statements as well as gives the overview of the company's financial position.
Important ratios enough to interpret financial statements of company
There are few important ratios enough to interpret financial statements. These are given below,
(i) Return On Equity:
Return on equity is a profitability measure which shows you how sufficient a company uses its equity capital to generate income.
Formula:
Return On Equity= (Net Profit/Shareholders Equity)
Interpretation:
A rising return on equity reflects the company well utilized the shareholders funds. Ideally, a company return on equity should be more than 20%.
A falling return on equity reflects the company not able the manage shareholder's fund.
(ii) Debt To Equity:
Debt to equity ratio is a solvency ratio that reveals the amount of debt taken by the company per rupee of the shareholder's fund.
Formula:
Debt to Equity=Total Debt/Shareholders Equity
Interpretation:
Generally a higher D/E ratio( more than 1) indicates weaker Solvency of the company that means company doesn't comfortably repay the long term liabilities.
A lower D/E ratio( less than 1) reveals the healthier Solvency of the company that means the company does comfortably repay the liabilities.
(iii) Current Ratio:
The current ratio also known as "working capital" ratio that express the current assets are sufficient to pay off the current liabilities within on time.
Formula:
Current Ratio=Current Assets/ Current Liabilities
Interpretation:
Generally current ratio more than 1 indicates that a good Liquidity of the company and company is able to pay off its short term obligations.
Current ratio less than 1 depicts that company does not have enough resources to pay its dues on timely.
(ii) Debt To Equity:
Debt to equity ratio is a solvency ratio that reveals the amount of debt taken by the company per rupee of the shareholder's fund.
Formula:
Debt to Equity=Total Debt/Shareholders Equity
Interpretation:
Generally a higher D/E ratio( more than 1) indicates weaker Solvency of the company that means company doesn't comfortably repay the long term liabilities.
A lower D/E ratio( less than 1) reveals the healthier Solvency of the company that means the company does comfortably repay the liabilities.
(iii) Current Ratio:
The current ratio also known as "working capital" ratio that express the current assets are sufficient to pay off the current liabilities within on time.
Formula:
Current Ratio=Current Assets/ Current Liabilities
Interpretation:
Generally current ratio more than 1 indicates that a good Liquidity of the company and company is able to pay off its short term obligations.
Current ratio less than 1 depicts that company does not have enough resources to pay its dues on timely.
(iv) Return On Assets:
The Return On Assets is also called as 'Return On Total Assets' is profitability ratio that measures how efficiently a company uses its total assets to create profits during a period.
Formula:
Return on assets=(EBIT/Total Assets)×100
Interpretation:
a higher ratio indicates that the managerial ability and profitability of the organization.
A lower ratio indicates that the managerial incompetence regarding utilization of assets towards earnings of profit.
(v) Earnings Per Share:
Earnings per share reveals that the portion of a company's earnings that is allocated to each outstanding share of a company.
Formula:
Earnings Per Share=Net Profit/No. of Outstanding Shares
Interpretation:
The increasing EPS indicates the growing profitability business and good managerial efficiency of the company. A higher EPS ratio is deliberated the mark of a powerful business.
The Return On Assets is also called as 'Return On Total Assets' is profitability ratio that measures how efficiently a company uses its total assets to create profits during a period.
Formula:
Return on assets=(EBIT/Total Assets)×100
Interpretation:
a higher ratio indicates that the managerial ability and profitability of the organization.
A lower ratio indicates that the managerial incompetence regarding utilization of assets towards earnings of profit.
(v) Earnings Per Share:
Earnings per share reveals that the portion of a company's earnings that is allocated to each outstanding share of a company.
Formula:
Earnings Per Share=Net Profit/No. of Outstanding Shares
Interpretation:
The increasing EPS indicates the growing profitability business and good managerial efficiency of the company. A higher EPS ratio is deliberated the mark of a powerful business.
The decreasing EPS reveals managerial inefficiency and poor financial position of the company.
(vi) Net Profit Margin:
Net profit margin represents that how much percentage of profit earned of a firm from its total revenue.
Formula:
Net Profit Margin=(Profit/Revenue)×100
Interpretation:
A high net profit margin means an organization is able to effectively control its costs and deliver products or services at significantly higher prices than its costs.
(vi) Net Profit Margin:
Net profit margin represents that how much percentage of profit earned of a firm from its total revenue.
Formula:
Net Profit Margin=(Profit/Revenue)×100
Interpretation:
A high net profit margin means an organization is able to effectively control its costs and deliver products or services at significantly higher prices than its costs.
A low profit margins mean that an organization uses an inefficient cost structure and pricing strategy.
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