Valuation ratios are the only group of business ratios that are externally and not internally driven. The market dictates valuation ratios. All three core valuation ratios are determined by the market price of the stock. All three have the same numerator, the market share price or market capitalization value of the company.
Business Principles Accounting
Accounting’s primary principle is the measurement of economic activity. The American Institute of Certified Public Accountants provide the concepts and principles in measuring economic activity and how those financial transactions are recorded.
The price to sales ratio is a marginal valuation ratio at best. It is really an offshoot of an antiquated concept of valuing a business. In the past, one of the more common methods to value a business deal was to use a multiplier of sales. The price to sales ratio used with business ratios is similar. Simply stated, the price to sales ratio is the entire market value of the company (the price) as a function of revenue (sales).
Leverage refers to the ability to lift a heavier load using a fulcrum and a lever. The common image is a board on a triangular pivot point with a heavy weight (M1) on one end and a lighter weight (M2) on the other. As the lever shifts towards the lighter load it starts to lift the heavier weight. In effect, as the distance ‘b’ gets longer, it becomes easier to lift M1. This principle works with finances too. How so?
The price to cash flow ratio is a valuation tool used to assist buyers and sellers of stock in determining timing of purchases or the disposition of shares. Unlike the other valuation ratios, this particular ratio utilizes the cash flows statement in determining the outcome. The formula is simple:
Price to Cash Flow = $Market Price of a Share of Stock/Cash Flow in Dollars Per Share of Stock
The majority of activity ratios measure the ability of the company to turn assets into earnings. All businesses utilize a simple principle, buy an asset at a low price and sell it at a higher price. Even service based businesses do this. Labor is purchased for a certain value and then sold for a much higher price. Retail businesses purchase inventory and then turn around, mark it up and then sell it to make a profit. There isn’t any business out there that doesn’t exercise this basic business principle.
Job costing reports are management tools used to evaluate project or production performance against a known or estimated standard. They are used in many business sectors and their respective industries. The primary purpose of job costing reports is to identify discrepancies or beneficial results, usually in the form of financial values. They can be used to report both financial and numerical production outcomes.
Liquidity ratios are a group of ratios used to measure the ability of a business operation to meets its current obligations. Liquidity ratios are similar to the initial medical tests a patient receives at a doctor’s visit. Doctors take blood pressure, temperature, and pulse rate. The doctor wants assurance that the primary indicators of health are good. Liquidity ratios are exactly the same. The user wants to know that the basic measurements of a business indicate good health today.
Purchase orders are requests to a seller to provide a certain product or service. Purchase orders are a business tool to control both physical and financial outcomes related to operational activities. For publicly traded entities, they are required as a function of internal controls to minimize defalcations.
Accounting is the process of recording economic activity and organizing this information in a format to inform owners about financial results. It all begins with the journals and ledgers. The initial entry is recorded in one of many journals and then transferred to the respective ledgers where the data is summed and reported to the …