Financial Ratio Analysis: Understanding Key Metrics
Understanding Key Financial Ratios
The availability ratio indicates the ability to cover debt balances with liquid assets. The guideline value is 0.3 to 0.4. For example:
- A ratio of 0.10 suggests liquidity problems and an inability to cover debt with liquid assets.
- A ratio of 0.35 falls within the optimal range, indicating no liquidity problems and the ability to cover debts smoothly.
- A ratio of 2.0 indicates excess liquidity, meaning no liquidity problems and the ability to cover debts smoothly.
The solvency ratio (total liabilities / total assets) helps assess solvency. The optimal value lies between 1.7 and 2. Examples:
- A ratio of 3 indicates an excess, suggesting that the company will not have problems with liabilities/total assets. It also indicates a healthy situation where assets exceed liabilities, implying that the company is primarily financed by its own capital. In this case, the company should consider investments that yield higher returns.
- A ratio of 1 indicates a deficit, suggesting potential problems with liabilities/total assets. The company may need to renegotiate debt to change the conditions.
- A ratio of 1.8 falls within the optimal range, indicating no problems with liabilities/total assets.
The liquidity ratio (current assets / current liabilities) indicates short-term solvency. The guideline value is 1.5 to 1.8. For example:
- A ratio of 1 indicates a deficit and potential problems paying current liabilities. Possible solutions include:
- Renegotiating short-term debt to make it enforceable in the long term.
- Selling unproductive assets and using the cash to pay off short-term debts.
- Obtaining a long-term loan to pay off debts.
- A ratio of 3 indicates an excess, suggesting that the company may have liquid assets that yield low returns. The company should consider investments that provide higher returns.
- A ratio of 1.7 falls within the optimal range, indicating no short-term solvency problems.
The cash ratio indicates immediate liquidity. The guideline value is 0.8 to 1.2. For example:
- A ratio of 0.07 indicates a deficit and immediate liquidity problems.
- A ratio of 0.8 falls within the optimal range, indicating no immediate liquidity problems.
- A ratio of 2.8 indicates excess liquidity, meaning no immediate liquidity problems.
The debt structure ratio calculates the required percentage of current liabilities/total debt. The optimal value is between 0.2 and 0.5. For example:
- If the company’s current liabilities represent only 0.07 of total debt, the company should consider investing assets in more productive or higher profitability ventures.
- A ratio of 1 indicates that the company is highly indebted in current liabilities, which can lead to payment problems. To fix this, the company could renegotiate current liabilities debt into long-term debt or obtain a long-term loan to settle this debt.
- A ratio of 4 indicates that the company has no problems dealing with current liabilities debt.
Financial return: Measures the net profit generated in relation to the investment of the company’s owners.
Increase profitability:
- Increasing margin: Raising prices, reducing costs, or both.
- Increase rotation: Selling more, reducing assets, or both.
- Increase leverage: Increasing debts, which results in a greater split of assets between resources.
Profitability: Understanding the evolution and causes of the productivity of the company’s assets.
Increase you can: Sell more or reduce the most expensive or sell assets to reduce expenses.