Whether you are a financial professional or an investor, analyzing financial statement information is crucial. But there are so many different numbers that it can seem tedious and very intimidating to go through them all. But if you know what some of the most important numbers in these statements are, like financial ratios, you’ll probably be on the right track.
The following financial ratios are derived from common income statements and used to compare different companies within the same industry. There are other ratios that are taken from an income statement, although the ones below represent some of the most common.
Key points to remember
- Financial ratios are used to compare companies in the same industry.
- These ratios are derived from the income statements.
- Some of the more common ratios include gross margin, profit margin, operating margin, and earnings per share.
- The price-to-earnings ratio can help investors determine how much they need to invest to get a dollar of that company’s earnings.
Gross margin represents the portion of a company’s sales that it retains after incurring the direct costs associated with the production of its goods and services. This ratio is therefore the percentage of revenue available for profit or reinvestment after deducting cost of goods sold (COGS). So if a business has a gross margin of 40%, that means it keeps 40 cents for every dollar it earns. He uses the rest on operating expenses.
The gross margin can be calculated in two ways: by dividing the gross margin by the net sales or by subtracting the COGS from the net sales of the company.
Financial ratios are used to analyze different categories including corporate debt, liquidity, and profitability.
A profit margin ratio is one of the most commonly used ratios to determine the profitability of a business activity. It shows the profit per sale after deducting all other expenses. Plus, it shows how many pennies a business generates in profit for every dollar in sales. So if Company X reports a profit margin of 35%, that means its net income was 35 cents for every dollar generated.
In order to determine the profit margin, you must divide the after-tax net income by the net sales.
A company’s operating margin is equal to operating profit divided by net sales. This is used to show how much income is left after paying for variable costs such as wages and raw materials. This is the same as the company’s return on sales and indicates how well that return is being handled.
Earnings per share
It is one of the most cited ratios in the financial world. The result of net income minus preferred stock dividends, which are then divided by the average outstanding stock, earnings per share is a crucial determinant of a company’s stock price because of its use in calculating the share price. price-earnings ratio.
Higher EPS means more value because investors are more likely to pay for a company with higher profits.
Many investors view earnings per share as a way to determine which stocks they favor by comparing the ratio with the stock price. This helps them discover the value of profits, giving them a sense of how a business will grow in the future.
The price-to-earnings, or P / E ratio, is calculated by taking the market value per share divided by the earnings per share. This is one of the most widely used stock market valuations and typically shows how much investors pay per dollar of profit. Simply put, this ratio tells an investor how much to invest in a business in order to receive a dollar from that business’s profits. For this reason, it is often referred to as the price multiple.
If a company has a high P / E ratio, it can mean that its stock price is high relative to earnings, making it potentially overvalued. A low P / E, on the other hand, may indicate that its stock price is low relative to its earnings.
Times interest earned
Interest Time Earned (EIR) is an indication of a company’s ability to honor its debts. Divide the earnings before interest and taxes, or EBIT, by the total annual interest charges and get the ratio multiplied by the interest earned.
Return on equity
Return on equity is another critical assessment for shareholders and potential investors and can be calculated by dividing after-tax net income by weighted average equity, although there are several other variations. This indicates the percentage of after-tax profits that the company has earned.