As a finance or accounting professional, you can be forgiven if you don’t want to spend time poring over EDGAR data, 10-Ks or 10-Qs looking for anomalies or insights. There have been many such accountants before you. That’s why ratios were invented. Ratios standardize metrics and allow you to compare business metrics that matter against each other.
Typically, ratios fall in four categories, based on the information they communicate:
Together, they turn the complex picture of public financial data into a much more standardized set of numbers. But if you’re looking for the easiest ratios to evaluate, where do you start?
Here are a few of the fundamental ratios:
This is a great way to understand total liquidity, and often more reliable than other ratios. The quick ratio is basically the cash, securities and accounts receivables divided by liabilities. It’s easy to understand because it only uses liquid assets without inventory or other non-cash assets.
Gross Profit Margin
This ratio is a great way to understand the efficiency of operations. It shows how much profit a product or service makes without accounting for overhead. It can vary drastically for businesses with different operations models.
Total Asset Turnover
This ratio measures a company’s ability to generate sales. Capital-intensive businesses will have a lower total asset turnover than non-capital-intensive businesses.
Contribution Margin Ratio
This ratio indicates the incremental profit resulting from a given dollar change of sales. If a company's contribution ratio is 20%, then a $50,000 decline in sales will result in a $10,000 decline in profits.
Debt to Total Capital Ratio
This ratio measures how much debt the equity holders within a company are making use of, and provide a snapshot of the overall risk inherent in the company.
Don’t forget that industries have their own insights.
Since most industries are specialized, with different operating costs, revenue models and risk factors, they all have different ratios that matter. Banking, for instance, is often concerned with the interest on loans, so they’re concerned with Return on Assets and Nonperforming Loans to Total Loans. Apple, as a consumer electronics company is mostly concerned with Gross Margin and Price-to-Earnings.
And anomalies always abound.
It’s important to remember that ratios can always be affected by anomalies like seasonal sales, major, one-time investments, management changes or other aberrations in the everyday cycle of business, so they’re best used in context with other metrics to understand a full picture.
Ratios are an easy way to understand a business from the big picture, without combing through data. And idaciti is an easy way to understand ratios and so much more. For more on the insights within your business, schedule your demo today.