Financial ratios are the most important tools for the investors to evaluate a company's profitability, efficiency and valuation. Ratios help to analyze the financial data of a company.
It allows the investors to check the crucial information about a company's profitability, efficiency, debt repayment ability and also other factors.
The valuable number is taken from the company's financial statement and calculated the number with the help of these ratios. Let's see what these ratios are and what they mean about a company!
1. Earnings Per Share (EPS):
Earnings Per Share is an important parameter of the profitability of the company. The earnings per share ratio indicate that the percentage of a company's earnings is distributed to each outstanding share of a company. EPS stands for earnings per share.
Earnings per share is an indication of how much profit is earned per share the company has issued and is a widely used metric to tally the corporate quality.
Earnings per share are used to compute the price to earnings (P/E) Valuation ratio.
Earnings Per Share = ( Net Profit - Preferred Dividends ) / End-of-Period Common Shares
Outstanding
The earnings per share ratio is a significant method used to compute and make an investment decision. Earnings per share are also called Net income per share. The higher the company's EPS, the better the performance and the more profitable it is.
2. Price to Earnings (P/E) Ratio:
The price-to-earnings ratio also known as the P/E ratio establishes a relationship between a company's per stock price and its earnings per share. The P/E ratio measures a company's share price related to its earnings.
However, the price-to-earnings ratio shows the investors are willing to pay for a stock per rupee of income. The P/E ratio helps to value a company.
In another word, The price to earnings ratio allows investors or analysts how many times earnings investors or analysts are willing to pay. The price-to-earnings ratio is also known as the price multiple or the earnings multiple.
Price to Earnings (P/E) Ratio = (Market price per share/Earnings per share)
3. Return on Equity:
Return on equity or ROE is a profitability ratio that measures how efficiently a company uses its shareholders' equity capital to generate income.
ROE deals with only equity, so we only consider the equity shareholder fund and the return will consist of funds that belong to the shareholders.
In other words, ROE is also called Return On Net Worth, which also reveals how efficiently management is using equity funds. Generally speaking higher ROE = higher profit.
Return on Equity = (Net Profit/Shareholders equity)
4. Return on Assets (ROA) Ratio:
The return on assets is a financial ratio that helps evaluate the profitability of a company's total assets. The return on assets is also called "return on total assets" which measures how efficiently a company uses its overall resources to earn profits during a period.
In other words, ROA measures the level of earnings generated by a company's total assets.
However, the return on assets ratio helps both investors and analysts, how well managed entities limit investment in non-productive assets.
Higher the return on assets of a company better utilization of a company's assets to generate revenue.
Return on Assets = (Net Profit / Average Total Assets)
5. Net Profit Margin:
The Net Profit Margin is also known as “Profit Margin” is a financial ratio used to calculate the percentage of profit a company produces from its total revenue.
It measures the amount of net profit a company obtains per rupee of revenue gained.
Net Profit margin = (Net Profit ⁄ Total revenue x 100)
The profit margin ratio of a company can be different depending on which sector the company is in. As an investor keep analyzing the financial data every day.
A high net profit margin indicates that a business is pricing its products correctly and is exercising good cost control.
6. Debt to Equity (D/E) Ratio:
The debt to equity ratio is a leverage ratio that evaluates the amount of debt taken by the company per rupee of the shareholder's funds. It is reflected in long-term debt and equity.
Having an understanding of the long-term financial well-being of the company is often countered.
The ratio brings out how the capital structure of a company tends toward either debt or equity financing. A high debt ratio means more creditors than shareholders.
In contrast to the debt-to-asset ratio which uses total assets as a denominator, similarly, the debt-equity ratio uses shareholders' equity.
Debt to equity ratio = (Total Debt / Shareholders' Equity)
The debt-equity ratio is an essential metric used in corporate finance. The ratio gauges the ability to pay back a company its debts.
The debt-equity ratio may assist in understanding the portion of debt and equity of a company, therefore they can make reasonable determinations about vital financial strategies for their company.
7. Current Ratio:
The current ratio is a liquidity ratio that reflects the current assets or short-term assets that are sufficient to repay the current liabilities within one year.
It reveals to the investors and analysts how competently a company utmost the current assets to fulfil its short-term debts and other payables.
The current ratio assists to conduct the liquidity condition in the company. The current ratio is also known as the "working capital" ratio that establishes a relation between the current assets and current liabilities of the company.
Current Ratio = (Current Assets/ Current Liabilities)
It also shows the short-term financial position of the company. The higher the outcome, the greater the financial achievement of the company.
Conclusion:
These financial ratios are very useful for new investors and are dynamic in nature. It is important to calculate them every quarter and once a year after declaring the result.
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