Getting Started – The Basics of Financial Ratios

Although IBISWorld provides financials for the companies on the US Company Benchmarking, Standard and Poor's NetAdvantage provides company information includes a description of the company, stocks & bond issues, earnings estimates, dividend and split history and more. Financial statements are packed with numbers and figures that may seem confusing at first glance. That’s why you need a game plan. Using financial ratios will help you distill financial data into easy-to-use percentages that can be compared across companies or the broader industry.

Not sure which ratios to use? The 10 most common financial ratios fit into four broad categories:

Liquidity Ratios consider the value of liquid assets companies have on hand. Without quick access to cash, how will companies pay off short-term debts? This is why liquidity ratios matter.

1. Current Ratio: Current Assets / Current Liabilities

2. Quick Ratio: Liquid Current Assets / Current Liabilities

Profitability Ratios measure a company’s ability to generate profit relative to revenue. Does the company use its assets wisely to drive up profit and build value for shareholders? There are a few ways to tell.

3. Return on Equity: Net Income / Shareholder’s Equity

4. Return on Assets: Net Income / Total Assets

5. Profit Margin: Operating Profit / Net Sales

Leverage Ratios reveal how much capital comes in the form of debt or loans. Does the company rely too heavily on debt to finance their operations? Unsustainable debt levels can jeopardize financial health.

6. Debt Ratio: Total Liabilities / Total Assets

7. Debt-to-Equity Ratio: Total Liabilities / Shareholder’s Equity

8. Debt-to-Net Worth: Total Debt / (Total Assets – Total Liabilities)

Efficiency Ratios help assess how well a company uses its assets to manage its liabilities. How much time does the company need to generate cash from liquidating inventory?

9. Asset Turnover Ratio: Net Sales / Total Assets

10. Inventory Turnover: Cost of Goods Sold ÷ ((Beginning Inventory + Ending Inventory)/2)

Income Statement, Balance Sheet, and Cash Flow Statements

Below is a view into the financials found on a company benchmarking report, Company Overview tab. 

Putting Your Findings to Use with Benchmarking

Once you’ve calculated financial ratios, you’ll need something to compare them against. That’s where benchmarking comes in. Benchmarking can be used to compare financial ratios and other performance metrics against industry-wide or competitor best practices. It allows for detailed comparisons between companies and industries to pinpoint successes, failures and areas needing improvement.

When benchmarking financial ratios, best practices may differ from industry to industry. For example, the financial sector’s debt-to-equity ratios are often higher than other service industries because they regularly borrow large sums of money for lending. Before you start benchmarking, make sure your criteria reflect industry standards.

Other common metrics to benchmark include cost allocations within an industry, overall industry performance and external variables and drivers.

• Cost Allocation: Different industries face vastly different overhead, wage and purchase costs depending on their operations. By benchmarking cost allocations, you can begin to understand where these differences lie from industry to industry. Benchmarking also comes in handy when questioning how cost allocations have varied from year to year within the same industry.
• External Variables & Drivers: Revenue generation within an industry depends on a mixture of different variables and drivers. Comparing these factors against each other can help you estimate revenue trends by pointing out key macroeconomic drivers, such as unemployment, consumer spending, trade value and more.
• Industry Performance: Industry performance often hinges on the revenue generated over a predetermined period of time. Benchmarking revenue generation can help you compare different years within the same industry, or the same span of years across different industries.

When assessing competition and benchmarking, another element you need to take into account is the industry’s lifecycle.