Financial Ratios. An Overview

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Financial ratios (also called financial indicators) are factors that are used to evaluate accounting and financial units. Through which the relationship of each of two direct financial data analyzes current or past state of an organization, according to optimal levels defined for it.

They serve as the basis for decisions (problem identification, identification of operational vulnerability, information extraction), control (target / actual comparison), documentation and/or coordination (behavioral control).

Financial ratios are calculated on the basis of two or more numbers from financial statements of companies. These numbers can be obtained from the balance sheet or income statement. Less often they can be derived from the changes in equity or cash flow statement.

These ratios are used by debt issuers to analyze credit risk, company executives to assess staff performance (stock options) or projects. And stock market investors that try using the fundamental analysis to select securities with better prospects.

The ratios quantify many aspects of the business, but should not be used individually without considering the financial statements. Rather, it should be an integral part of the analysis of financial statements. The application of a ratio yields insights which come from a deeper analysis of events around the company.

Ratios enable you to make comparisons among companies, some sectors (eg, banking and petrochemicals), in different periods of time. As a relative indicator, two selected variables are placed in an appropriate relation to each other. Key figures provide condensed information.

Financial ratios are published in part by the companies themselves. The exact calculation of key figures in most cases is not standardized. So many key figures depend on the underlying accounting rules that differ internationally. A comparison of companies of different countries is therefore only conditionally possible.

Ratios which are related to each other can be combined into performance measurement systems. Known systems are the DuPont performance measurement system, and the ZVEI-RL-indicator system.

Of special significance are key figures in the comparison as well as operating in the so-called benchmarking. The key figure of the ‘best company’ represents the benchmark (or best practice), which other companies may want to emulate.

Ratio of total debt on investment measures the magnitude of borrowing or financing, within the total funding (consisting foreign funds and capital). And the formula is (Current Liabilities + Long Term Liabilities) * 100) / Total Assets = (PC + PLP) * 100) / AT.

Figures can be divided fundamentally into absolute and relative indicators.

    – Absolute figures: Their information content is defined by the significance of the value itself, such as cash flow, gross margin, EBIT. They comprise of individual values, totals, and average values.
    – Relative figures: the connection of two managerial levels of a key figure with elevated and/or specific significance

The relative strength of an index depends primarily on the factual context of the compared quantities.
 

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