Financial ratios

Financial ratios analysis is important in the fundamental analysis of companies. It is a quantitative method of gaining deep knowledge into a company’s liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement There are many ratios to analyze a company’s health, profit, Debt, etc. There are some basic ratios to analyze all types of companies. But we can’t use all these ratios to analyze a company. we can classify the companies sector-wise and need to find which ratios need to be analyzed. For each sector, there is a specific ratio to analyze. In this blog, we can look into specific ratios for each sector.

Key Financial Ratios for Banking sector:

Return on Assets (ROA)

This ratio shows how the company is profitable. ROA shows investors how the company using its assets. Higher ROA means it’s better for a bank because its earnings is more than the investment.

 

ROA Displayed in percentage.  ROA = Net income / Total Assets 

For example, Net income is 100 and Total assets is 1000 

ROA is 100/1000*100 = 10%.

 

Gross Non-performing assets (NPA) and Net (NPA):

If interest is not received for a quarter ( 3 months) loan becomes NPA. it shows how much then bank loan in danger. 

 

High NPA means the bank is at a poor level. 

Gross NPA are uncollected debt from people and organization. 

Net NPA are doubtful and unpaid debt from the sum of loan defaulted 

Dividing non-performance assets by total loans gives NPA Percentage.

 

Provisioning Coverage Ratio:

Against bad loans banks keeping some of their profits as a provision.

 

A high PCR Ratio above 70 % means the bank is safe. 

PCR = Total provisions / Gross NPA

 

Capital Adequacy Ratio:

CAR shows whether the bank has enough amount of money to bear the losses before the company becomes insolvent.
CAR = Tier 1 capital + Tier 2 capital / Risk-weighted assets

 

Tier 1 capital – Equity capital, ordinary share capital, intangible assets, audited revenue reserves

Tier 2 capital – Unaudited earnings, unaudited reserves

Risk-weighted assets – Minimum amount of capital must be held by banks

 

CASA Ratio:

It is the proportion of the current account and savings account in the total deposit of the bank.

 

CASA Ratio = CASA Deposits / Total Deposits

A higher ratio means more money deposited in current and savings accounts. It is good for banks. 

A lower ratio means banks rely on total funding and its affect the margin

 

Credit deposit Ratio:

It tells how much money banks raised from deposits have been given as loans. 

 

IF CD Ratio is more than 75% three fourth of the deposits are given as loans.

A lower CD ratio shows poor credit growth and a higher CD ratio shows strong demand for credit.

Credit  Deposit Ratio = Total Advances / Total Deposits * 100

 

Net Interest Margin:

Difference between interest earned by banks and interest paid by banks on deposits.

 

If NIM is positive, banks are operating profitably

Net interest margin = Interest revenue – Interest expenses / average earnings asset

Average Earnings balance = Average of beginning asset balance and ending asset balance.

 

Key Financial Ratios for Manufacturing Sector:

Inventory Turnover Ratio:

 

Inventory Turnover Ratio Measures the effectiveness of a company’s manufacturing process and how fast they are selling inventory compared with industry.

Low inventory turnover ratio indicates demand and sales are declining

A high inventory turnover ratio indicates, a company selling its goods quickly

Inventory Turnover Ratio = Cost of goods sold / Average Inventory

 

Return on Net Assets (RONA):

Return on Net Assets shows how well the company is using its assets to generate revenue.

 

Return on Net Assets = Net income of the Manufacturing plant / Net Assets.

Higher RONA means the company using its assets and working capital efficiently.

 

Return on capital employed (ROCE):

This ratio shows how the company using its capital to generate profits. It measures the company’s profitability and capital efficiency.

Higher ROCE Indicates profits are invested into the company for the benefit of shareholders and it’s a sign of a successful growth company.

ROCE= Capital Employed / EBIT​

EBIT=Earnings before interest and tax

Capital Employed=Total assets − Current liabilities

Interest coverage ratio:

 

This ratio measures how well the company paying its interest for its outstanding debt.

Low-interest coverage indicates, the company won’t be able to service its debt. The profit generated by the company is low and it can’t able to meet interest expenses on its debt.

High-interest coverage indicates, the company generates enough profits to service its debt.

Interest Coverage Ratio= EBIT / Interest Expense​

EBIT=Earnings before interest and taxes​

Key Financial Ratios to Analyze Tech Companies:

Debt to Equity Ratio:

Debt to Equity Ratio is very important for technology companies because most of the technology companies invested in other technology companies. Also, they invest more in new products and technology development.

 

Investors need to look at the debt of the company. If a debt to Equity ratio is too high means the company would become insolvent

Debt-to-equity ratio = Total debt / Total equity

 

 

Current Ratio:

Current ratio measures the company’s ability to pay its debts in short term.
Business in tech industry needs to fund all of its operations from current assets and cash from investors. Current ratio needs to be high.
A Current ratio of less than 1 indicates the debts in a year are greater than its assets.
A Current ratio greater than 1 indicates the company has more financial resources.
Current ratio = current assets / current liabilities

 

 

Cash Ratio:

Tech companies mostly use cash for their short-term obligations because they don’t have other current assets like inventory.
A high cash ratio means the company keeping too much cash on hand or the company didn’t save the cash well.
A low cash ratio means a company relying on sales to pay their monthly bills.
Cash Ratio = Cash + Cash Equivalents / Current Liabilities 

 

Cash Equivalents = marketable securities through acquisitions and investments

Gross Profit Margin:

High gross profit margin signals company is profitable. It measures the gross profit margin earned from sales.
Tech companies have few physical materials and a smaller workforce, for example, software and video game companies.
Compared to other industries, Established tech companies have always a high profit margin.
Gross Profit Margin = Net sales – the cost of goods sold / Net sales