BM Academy
Financial Ratios
“The Lower You Scroll, The Higher The Difficulty”
What types of ratios are there?
When it comes to financial ratios, there are various types that analysts and investors use to assess a company's performance and financial health. Some of the key financial ratios include:
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Financial ratios enable us to assess a company's profitability, liquidity, solvency, efficiency, and market performance. By analysing these ratios, we gain a deeper understanding of the company's strengths, weaknesses, and overall financial condition.
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Financial ratios facilitate benchmarking and comparison with industry peers, competitors, or historical data. This allows us to gauge how a company fares relative to others in its industry, identify trends, and spot potential areas for improvement or competitive advantage.
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Financial ratios provide crucial information for making informed decisions. They help investors, lenders, and stakeholders evaluate investment opportunities, assess creditworthiness, determine risk levels, and support strategic decision-making.
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By regularly monitoring financial ratios over time, we can track a company's performance, identify emerging trends, and evaluate the effectiveness of management strategies and initiatives. This helps in assessing whether a company is progressing towards its financial goals.
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Financial ratios can act as early warning signals, alerting us to potential financial distress or unfavorable trends. Significant changes or deviations in key ratios can highlight underlying issues that require attention and intervention.
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Financial ratios provide a common language for communicating financial information. They enhance transparency and facilitate effective communication between management, investors, analysts, and other stakeholders, fostering trust and informed decision-making.
Financial ratios serve a multitude of purposes, providing valuable insights into a company's financial performance. They act as a translator, converting raw financial data into meaningful insights that guide decision-making and provide a holistic view of an organisation's health. Listed are the reasons why we use financial ratios:
Why do we use ratios?
How do we use ratios in our analysis?
Financial ratios unlock vital information about a company's performance, profitability, liquidity, and much more. By carefully examining these ratios, we can decipher the company's financial health and make informed decisions.
Financial ratios serve as lenses, allowing us to see beyond the surface of financial statements. We analyse them in a holistic manner, observing their interrelationships and patterns. Financial ratios are like musical notes in a symphony. We listen attentively to their harmonious melodies, searching for discordant tones that may indicate areas of concern. By orchestrating these ratios, we create a symphony of financial analysis, uncovering both the strengths and weaknesses of a company.
A large portion of the art is understanding that discovering your own assessment of financial ratios within varying fields will set you apart from other traders.
What are the problems with financial ratio analysis?
Financial ratio analysis is a powerful tool for assessing a company's financial health, but it's not without its challenges. Let's explore some of the problems that can arise with financial ratio analysis:
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Financial ratios provide numerical insights, but they may lack context. Ratios alone cannot capture the full story behind a company's performance. It's essential to consider industry norms, economic conditions, and qualitative factors to obtain a comprehensive understanding.
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The accuracy and reliability of financial ratios heavily rely on the quality of the underlying financial data. Inaccurate or manipulated financial statements can lead to distorted ratios and misleading conclusions. Diligent verification of data sources is crucial to ensure the reliability of the analysis.
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Financial ratios represent a snapshot of a company's performance at a specific point in time. Changes in business conditions or financial variables can quickly render ratios outdated. Regular monitoring and updating of ratios are necessary to maintain relevance and accuracy.
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Financial ratios focus primarily on quantitative aspects of a company's performance. They may not capture qualitative factors such as management competence, brand value, or market dynamics, which can significantly impact a company's success. Supplementary analysis beyond ratios is often required to obtain a holistic view.
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Different industries have unique characteristics and operating models. Applying the same set of ratios across industries can be misleading, as what may be considered favourable in one industry could be unfavourable in another. Industry-specific ratios or benchmarks are necessary for accurate comparisons.
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Financial ratios are historical in nature, reflecting past performance. They may not be reliable predictors of future outcomes or potential risks. Investors and analysts must complement ratio analysis with forward-looking indicators and qualitative assessment to make informed decisions.
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Financial ratios provide condensed information, simplifying complex financial data into single metrics. However, this simplification can sometimes oversimplify the reality, masking nuances and intricacies that may be critical for decision-making. Caution is necessary to avoid over reliance on ratios without deeper analysis.
“By acknowledging and addressing these challenges, financial ratio analysis can be utilised effectively, providing valuable insights into a company's financial condition and performance. It's important to approach ratio analysis as part of a comprehensive analytical framework, considering both quantitative and qualitative factors to form a well-rounded perspective.”
