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Financial statement analysis is also referred to as ‘Quantitative Analysis’. It is one of the most important steps while analyzing a company from an investment perspective. Massive amounts of numbers in a financial statement may be bewildering and intimidating to a novice investor. Financial ratio analysis enables an investor to understand these numbers in an organized fashion. Balance sheet, Income Statement and Cash Flow Statements are the most important financial statements and if properly analyzed and interpreted can provide valuable insights into a company’s performance. |
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Profitability reflects the final result of a company’s business operations. Profitability Ratios are also called Income Statement Ratios since most of the items used in their calculations are picked up from the Income Statement. Profit margin ratios and rate of return ratios are the most commonly used profitability ratios. A comparison of profitability ratios with other competitors in the same industry can reveal relative strengths or weaknesses of a business. |
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Asset ratios measure the efficiency by which a company is using its assets (these include fixed assets, inventory and receivables). These ratios are generally applied by management to analyze the company’s performance over multiple periods. They serve as benchmarks or as warning signals on operational issues. Some of the most commonly used asset utilization ratios are described in the following section. |
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Liquidity ratios are sometimes referred to as Balance Sheet ratios since most of the variables are taken from the balance sheet. Liquidity ratios measure the short term solvency of a company. In other words, they indicate a company’s ability to meet its short term financial obligations. They are generally based upon the relationship between current assets and current liabilities. |
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Debt to Assets Debt to Asset ratios determine the proportion of external financing used to purchase business assets. A ratio of 0.6x indicates that 60% of the total assets are financed through external debt. It is calculated as: |
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