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 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

Operating Cash Ratio – Formula and Understanding
Unlike the other liquidity ratios that are balance sheet derived, the operating cash ratio is more closely connected to activity (income statement).
Operating Profit Margin – Formula and Understanding
Operating profit margin refers to the value earned as a percentage of net sales. The operating profit is often referred to as earnings before interest, taxes, depreciation and amortization, (EBITDA).
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.
Debt Ratio
The debt ratio reflects the percentage of assets covered by debt.
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.
Working Capital Turnover
Activity ratios measure performance of a current asset on the balance sheet. The working capital turnover is the most encompassing of all the activity ratios.
Cash Ratio
The cash ratio is a much more effective tool for small business than the traditional current or quick ratio.
Accounts Receivable Turnover Ratio
One of the activity ratios in business is the receivables turnover ratio or rate; it measures the frequency of collecting the entire balance of accounts receivable.
Net Profit
No other business term is so misunderstood, misstated, misleading or deceiving as the words ‘net profit’.
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.