Business Ratios

Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

Business RatiosBusiness ratios are used with financial information to compare companies of different sizes within the same industry. The goal is to discover the best investment for return on your stock purchase. Business ratios essentially equalize different size companies within the same industry. A common mistake is to compare two different industries within the same economic sector.

Business ratios are strictly a function of the financial reports audited by Certified Public Accountants. There are five widely accepted categories of financial business ratios. Each category has no less than two different ratios. 

 

 

1) Liquidity Ratios – measures the relationship between current assets and the corresponding current liabilities.
2) Activity Ratios – are used to compare balance sheet assets against the volume of sales or an income statement value. 
3) Leverage Ratios – assist with evaluating the use of debt to capitalize a company.
4) Performance Ratios – designed to reveal income statement performance.
5) Valuation Ratios – market driven information customarily tied to the market share price, it is the only set of business ratios not internally generated.

The ratios accepted as outstanding in one industry are not applicable to a different industry even one within the same sector. Utilizing ratios for comparisons is restricted to comparing companies within the same industry.

Value Investing Episode 1 – Introduction and Membership Program

  • Total Assets Turnover Rate – Formula and Analysis

    Total Assets Turnover Rate - Formula and Analysis
    Within the group of activity ratios, the total assets turnover rate is the broadest in scope. Similar to other activity ratios, it utilizes net sales as the numerator. However the denominator doesn’t focus in on a single balance sheet asset group like the working capital turnover or fixed assets turnover rates, it includes all assets.
  • Debt Ratio

    Debt Ratio
    Every business buys on account whether it is a traditional vendor account like that found in retail or simply using a credit card. A third party provides credit which creates debt for the business. The debt ratio reflects the percentage of assets covered by debt. 
  • Fixed Assets Turnover Rate

    Fixed Assets Turnover Rate
    The fixed assets turnover rate is another activity ratio whereby an income statement financial characteristic is compared to a balance sheet asset section. In this case, comparing adjusted sales against historical cost of fixed assets. This financial business ratio is only effective for business operations that are fixed asset intensive. With service based industries like carpet cleaning, professional firms ...
  • Working Capital Turnover

    Working Capital Turnover
    The activity ratios measure performance of a current asset on the balance sheet against a corresponding area of the income statement. The working capital turnover is the most encompassing of all the activity ratios; in effect, it is the most general of the activity ratios.  This particular ratio measures the ability of management to efficiently utilize ...
  • Cash Ratio

    Cash Ratio
    One of the liquidity ratios used in business is the cash ratio. It is a much more effective tool for small business than the traditional current or quick ratio. Although the cash ratio is more difficult to manipulate in small business, most entrepreneurs miscalculate the result
  • Accounts Receivable Turnover Ratio

    Accounts Receivable Turnover Ratio
    One of the activity ratios in business is the receivables turnover ratio or rate. This ratio measures the frequency of collecting the entire balance of accounts receivable during a standard accounting year. The ideal turns rate is twelve with a higher value indicating an aggressive collection process. A lower value is a warning about accounts receivable management.
  • Net Profit

    Net Profit
    No other business term is so misunderstood, misstated, misleading or deceiving as the words ‘net profit’. Accounting defines net profit as the amount earned after all associated costs and expenses are subtracted from the associated sales. The larger or more public the company the more reliable the dollar value as stated on the bottom line. But ...
  • Current Ratio

    Current Ratio
    The current ratio is an inappropriate relationship to use or rely on in small business. The ratio is best suited for large publicly traded organizations. This article explains the basic formula for the current ratio, how to identify the ratio in reading financial statements, its purpose and the many drawbacks for its use with small business.
  • Business Ratios (Introduction)

    Business Ratios (Introduction)
    Ratios are used in business to compare companies of different sizes within the same industry. The goal is to discover the best investment for return on your stock purchase. Business ratios essentially equalize different size companies within the same industry. A common mistake is to compare two different industries within the same sector (explained below).
  • Interest Coverage Ratio

    Interest Coverage Ratio
    The last of the leverage ratios isn’t really a pure leverage indicator but augments the debt ratio. Debt requires the payment of interest and so an indicator of the ability to pay this interest is needed. This is the interest coverage ratio.