Meaning of financial performance ratios<\/h2>\n\n\n\n
A ratio refers to “the indicated quotient of two mathematical expressions and as the relationship between two or more things.” Here, financial performance ratios or accounting<\/a> ratios represent a mathematical expression of the relationship between accounting figures stated in the financial statements, which are connected with each other in some logical manner.<\/p>\n\n\n\n The analysis of financial performance ratios is based on the ground that a single accounting figure by itself might not communicate any meaningful information to the users. However, when it is expressed relative to some other figure, it can definitely provide some significant information.<\/p>\n\n\n\n When it comes to the sustainable growth of a start-up enterprise, it becomes of utmost importance to understand the health of the business<\/strong><\/a> firm. Here, the financial performance ratios tell us how healthy and financially viable a start-up firm is.<\/p>\n\n\n\n A sought-after technique of analyzing the performance of a start-up business concern or other established enterprise is that of financial ratio analysis. It is construed as a tool of financial management<\/strong><\/em><\/a> and attains crucial significance. The feature which accentuates the application of financial ratio analysis is that it presents facts on a comparative basis<\/a> and enables drawing of inferences regarding the overall performance of a business.<\/p>\n\n\n\n It must be noted that the analysis of financial performance ratios is not just comparing different figures from the balance sheet, income statement, and cash flow statement. It also comprises the comparison of the numbers against previous years, other companies, the industry, or even the economy in general for the ultimate purpose of financial analysis.<\/p>\n\n\n\n The main objective of financial performance ratios is that all stakeholders (owners, investors, lenders, employees, etc.) can draw valuable conclusions about the following:<\/p>\n\n\n\n Financial Statement analysis with the aid of financial performance ratios is useful to various stakeholders to obtain the desired information about the start-up or other business entity. For instance,<\/p>\n\n\n\n The sources of information for financial statement analysis are:<\/p>\n\n\n\n There are four major categories of financial performance ratios which are as under:<\/p>\n\n\n\n Liquidity or short-term solvency is concerned with the ability of the start-up or other established entity to pay its short-term liabilities. The inability to pay-off short-term liabilities influences its credibility as well as its credit rating. Also, continuous default on the part of the enterprise leads to the situation of commercial bankruptcy<\/a><\/strong>, which may eventually cause its sickness and dissolution. Short-term lenders and business creditors are very interested in knowing the state of liquidity of the business because of their financial stake. Some of the important financial performance ratios used to assess the liquidity position of start-ups and other businesses include:<\/p>\n\n\n\n Liquidity\nRatios and How are they calculated?<\/strong><\/p>\n\n\n\n Interpretation: <\/strong>It\nis one of the most common measures of short-term liquidity. It answers the\nquestion that whether your business has adequate current assets to satisfy the\npayment schedule of its current debts with a margin of safety for possible\nlosses.<\/p>\n\n\n\n Quick Assets =\nCurrent Assets − Inventories − Prepaid expenses<\/p>\n\n\n\n Interpretation: <\/strong>This\nratio is a much more conservative measure of short-term liquidity than the\ncurrent ratio. As quick assets comprise only cash and near-cash assets, this\nratio indicates the start-up’s ability to instantly use its near-cash assets to\npay down its current liabilities as and when they fall due.<\/p>\n\n\n\n Interpretation: <\/strong>It acts more as a measure of cash flow\nthan a ratio. The outcome of this calculation must be a positive number.\nBankers often look at ‘Net Working Capital’ over time to determine a company’s\ncapability to face financial crises and loans are often tied to minimum working\ncapital requirements.<\/p>\n\n\n\n The leverage ratios are referred to as those financial performance ratios that measure the long-term stability and capital structure<\/strong><\/a> of the start-up firm or other business entities. Such ratios indicate the mix of funds provided by owners and outside lenders and assure the lenders of the long-term funds in respect of:<\/p>\n\n\n\n These ratios offer an insight into the financing techniques adopted by a start-up business, and, as a consequence, focus on the long-term solvency position. Some of the important financial performance ratios used to assess the long-term solvency position of start-ups and other mature businesses include:<\/p>\n\n\n\n Leverage Ratios and How are they calculated?<\/strong><\/p>\n\n\n\n Interpretation: <\/strong>It\ndepicts the proportion of owners’ funds to the total capital fund invested in\nthe start-up or other business. It is believed that the higher the proportion\nof shareholders’ fund, the lower is the degree of risk.<\/p>\n\n\n\n Interpretation: <\/strong>It\nis used to analyze the long-term solvency of a business firm. A high debt to\nequity ratio means less protection for creditors, and a low ratio, on the other\nhand, signifies a wider safety cushion. This ratio is very often referred to in\ncapital structure decisions and is also used by lenders as it shows relative\nweights of debt and equity.<\/p>\n\n\n\n Shareholders’\nequity = Equity and preference share capital + post accumulated profits (excluding\nfictitious assets etc.)<\/p>\n\n\n\n Interpretation: <\/strong>In\naddition to the debt-equity ratio, many a time capital gearing ratio is also\ncomputed to showcase the proportion of fixed interest (dividend) bearing\ncapital to funds belonging to equity shareholders or net worth.<\/p>\n\n\n\n Interpretation:\n<\/strong>It shows the firm’s\nability to service the fixed liabilities, i.e., by establishing a relationship\nbetween fixed claims and what is normally available out of which such claims\nneed to be paid. This ratio shows the extent to which EBIT may fall without\ncausing any embarrassment to the entity regarding the payment of fixed interest\ncharges.<\/p>\n\n\n\n Activity or turnover ratios are those parameters which are employed to evaluate the efficiency with which the business firm or a start-up manages and utilizes its assets. These are often also called as ‘Asset management ratios’. These ratios normally indicate the frequency of sales with respect to its assets. Such assets may be capital assets or working capital or average inventory. Some of the important financial performance ratios used to assess the degree of efficiency in the management and utilization of assets of start-ups and other businesses include:<\/p>\n\n\n\n Activity\nRatios and How are they calculated?<\/strong><\/p>\n\n\n\n Interpretation: <\/strong>It\nhighlights the firm’s ability of generating sales\/ Cost of Goods Sold per rupee\nof long term investment. The higher the ratio, the more efficient is the utilization\nof owner’s and long-term creditors’ funds. Net Assets include Net Fixed Assets\nand Net Current Assets (Current Assets – Current Liabilities).<\/p>\n\n\n\n Interpretation: <\/strong>This\nratio establishes the relationship between the cost of goods sold during the\nyear and average inventory held during the year. It measures the efficiency\nwith which a start-up firm utilizes or manages its inventory. It shows how fast\ninventory is used or sold. A high ratio is preferred from the view point of\nliquidity and vice versa. A low ratio means that inventory is not used\/ sold\nand remains in the warehouse for a long time.<\/p>\n\n\n\n Interpretation: <\/strong>The speed with which accounts receivables\nare collected impacts the liquidity position of the business firm. This ratio\nthrows light on the collection and credit policies of the entity. It captures\nthe efficiency with which management is managing its accounts receivables.<\/p>\n\n\n\n Interpretation: <\/strong>This ratio shows the velocity of payables\npayment by the business enterprise. A low creditor’s turnover ratio showcases\nliberal credit terms granted by suppliers, whereas a high ratio shows that\ncreditors’ accounts are settled rapidly.<\/p>\n\n\n\n The profitability ratios capture the profitability or the operational efficiency of the start-up firm or other mature business enterprise. These ratios reflect the final results of business operations, and are; therefore, some of the most closely watched and widely quoted ratios. The business management attempts to maximize these ratios in order to maximize firm value. The business results may be assessed in terms of its earnings with reference to a given level of assets or sales or owner’s interest, etc. Some of the important financial performance ratios used to assess the degree of profitability of start-ups and other businesses include:<\/p>\n\n\n\n Profitability\nRatios and How are they calculated?<\/strong><\/p>\n\n\n\n Interpretation: <\/strong>This\nratio envisages the relationship between net profit and sales of the start-up\nentity. It identifies the proportion of revenue that makes its way into\nprofits. A high net profit ratio shall assure positive returns of the\nenterprise.<\/p>\n\n\n\n Interpretation: <\/strong>ROI is the most significant profitability\nratio, which depicts the percentage of an overall return on funds invested in\nthe start-up business by its owners. It measures the overall return of the\nbusiness on investment\/ equity funds\/capital employed\/ assets.<\/p>\n\n\n\n Interpretation: <\/strong>It is just another variation of ROI. ROCE\nmust always be higher than the rate at which the enterprise borrows. Capital\nemployed implies nothing but Net worth plus Debt. It tells the owners whether\nor not all the effort put into the business has been worthwhile.<\/p>\n\n\n\n Interpretation: <\/strong>EPS\ndenotes the overall profit derived for each share in existence over a\nparticular period. The firm’s profitability from the point of view of ordinary\nshareholders can be appraised in terms of earnings on per share basis.<\/p>\n\n\n\n Interpretation:\n<\/strong>At any point in time,\nthe P\/E ratio is a parameter of how highly the market accords value to a\nbusiness. It indicates the expectations of equity investors about the earnings\nof the entity. It relates earnings to market price and is usually considered as\na holistic measure of the growth potential of an investment, risk\ncharacteristics, shareholders orientation, corporate image and degree of\nliquidity.<\/p>\n\n\n\n Financial performance ratios are relevant in assessing the performance of a start-up firm or other mature entity in respect of the following aspects:<\/p>\n\n\n\n No business can succeed without proper planning and budgeting. Financial analysis through ratios is a step towards evaluating the overall business performance. We at Enterslice<\/strong><\/a>, have a team of expert financial analysts who can help you assess the business performance of your organisation to assist you in long-term growth planning.<\/p>\n\n\n\nAssessment of business performance through ratio analysis<\/h2>\n\n\n\n
The objective of financial performance ratios<\/h2>\n\n\n\n
The usefulness of financial performance ratios<\/strong><\/h2>\n\n\n\n
Sources of computing financial performance ratios<\/strong><\/h2>\n\n\n\n
Types of financial performance ratios<\/h2>\n\n\n\n
![\"Types](\"https:\/\/enterslice.com\/learning\/wp-content\/uploads\/2020\/04\/Untitled-3.png\")
<\/figure><\/div>\n\n\n\nLiquidity Ratios\/Short-term solvency ratios<\/strong><\/h2>\n\n\n\n
Leverage Ratio\/Long-term solvency ratios<\/h2>\n\n\n\n
Activity Ratios\/Efficiency Ratios\/Performance Ratios\/Turnover ratios<\/h2>\n\n\n\n
Profitability Ratios<\/strong><\/h2>\n\n\n\n
Takeaway<\/h2>\n\n\n\n