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

  • Gross Profit Margin

    Gross Profit Margin
    The difference between the sales price and the cost of the product or service rendered is known as gross profit margin in business. It is traditionally the amount identified on the income statement or a tax return as the amount earned after cost of sales a.k.a cost of goods sold, cost of services rendered, etc. ...
  • Debt to Equity Ratio

    Debt to Equity Ratio
    Another leverage ratio used to evaluate the financial integrity of a business is the debt to equity ratio. It is strictly a bottom half balance sheet ratio. Its result explains the relationship of volume of debt and corresponding equity to finance the operations of a business, i.e. the purchase of assets.
  • Net Profit Margin

    Net Profit Margin
    The net profit margin reflects the profitability of the company as a percentage of net sales. It is one of the performance ratios used in evaluating business. Interestingly, some consider it the most important ratio. These users of business ratios take a very simplistic approach towards business evaluation. 
  • Return on Assets

    Return on Assets
    One of the performance ratios used in business identifies the overall ability of management to efficiently utilize resources to generate a profit. Corporate resources include human knowledge/skills and the balance sheet assets of the business. The labor component is unquantifiable in terms of dollars, but assets with a dollar value associated with them are reflected on the ...
  • Accounts Payable Turnover Rate (Ratio)

    Accounts Payable Turnover Rate (Ratio)
    The accounts payable turnover rate is a business activity ratio measuring the frequency of the company’s ability to pay its vendors and suppliers. The numerical value is customarily reported as an annual value. The higher the number, the more often the payables are cleared (paid). A ’12’ would indicate that all payables are paid every month (360 days/12 = ...
  • Inventory Turnover Rate

    Inventory Turnover Rate
    One of the many ratios used in business, the inventory turnover rate is often misunderstood, miscalculated and misused. The traditional business course in academia explains that ideally the inventory turnover ratio (rate) is the highest number possible. This higher value means the business operation is selling the product as fast as possible. This in turn signifies that ...
  • Fixed Assets To Debt Relationship

    Fixed Assets To Debt Relationship
    Every business owner, especially young entrepreneurs, must understand how long-term debt  is used to finance the purchase of fixed assets. It is a basic principle especially for start-ups. There is a relationship that exists between the two. If created correctly, profitability is enhanced and cash flow is maximized.
  • Quick Ratio – Definition, Explanation and Proper Use

    Quick Ratio – Definition, Explanation and Proper Use
    The quick ratio is a formula used in business to identify the ability of a business to pay its current liabilities. It is also known as the ‘Acid Test’ formula (ratio). In the large markets this formula is one of the financial industry ratios used to value the stock of a corporation. In the arena of the small ...