Before an investor expands their portfolio by investing in a business, glancing at that business’s financial statements will not always help make an educated decision on whether to invest. To gauge the actual financial representation of a business, the investor needs to filter the financial information to get more solid and conclusive answers.
Analysis of financial statements or calculating financial ratios can provide a deep and clear picture of a business’s financial health. Determining financial ratios can be a difficult task. Moreover, dozens of financial ratios might be available to the investor, making it confusing. However, the investor must investigate the financial health of a business before deciding to invest in it.
While assessing the business’s financial information and gathering the industry average, various websites are used, including Bloomberg, Morning Star, and Yahoo Finance. Some other non-financial factors should also be considered while assessing the business’s performance, as it is important to provide information relevant to the business’s stakeholders.
Sometimes, the business management uses data manipulations to keep their position in the market attractive to a potential investor. Thus, along with financial indicators, the non-financial statement should also be determined to conclude its financial performance. The non-financial statement is an auditor’s report that qualifies or disqualifies the business’s financial statements.
The analysis will determine the business’s competitive strength by accompanying a horizontal analysis. Furthermore, based on these analyses, certain decisions associated with the business’s external and internal stakeholders can be made.
The business aims to seek an upward trend in its profits and maintain a competitive market position. Moreover, the business should maintain a consistent focus on certain growth strategies, which fosters good business practices and financial growth.
Financial ratios can help assess the potential of a business to be a good and profitable investment. Here are five financial ratios that can be effectively used to assess the investment value of a business.
Operating Profit Margin
Operating Profit Margin determines the business’s profitability level, which illustrates the business’s capabilities to generate profit through its sales revenues. The business can attain a higher ratio in its operating profit margin by managing the cost-effectively, reducing the cost of unproductive activities among different business operations. However, certain uncontrollable factors or unfavorable economic consequences can negatively affect the business’s profit generation.
Interest Coverage Ratio
Interest Coverage Ratio determines the business’s efficiency by analyzing its capacity to pay off its interest expenses with the generation of operating profits. A business’s financial situation is considered more favorable when it has a higher level of coverage ratio. This situation determines that the business can utilize debt to acquire funds from the market.
Return on Captial Employed
Return on Capital Employed determines the business’s efficiency level to generate profits on the business’s funds from the market. Moreover, it is the most important ratio from the perspective of an investor. If the individual is making an investment decision to become a shareholder in a business, the investor must know its existing ROE.
Asset Turnover
Asset turnover ratio is an efficiency ratio used to govern the business’s capabilities to generate sales revenues on the business’s total assets, which can include fixed and current assets.
PE Ratio
Price to Earnings ratio depicts how much shareholder is willing to acquire shares from the market, regarding its market value and the associated earnings per share. It determines the attraction of shares in the eyes of the business’s shareholders.
To put it in a nutshell, the ratio which has been mentioned above is a key ratio. A shareholder must comprehend these financial ratios because they can provide valuable discernment into the business’s financial picture and help make an informed and prudent decision.
About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual bookkeeping, providing service to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks™️ file, critical financial documents, and back-office tools in an efficient and secure environment. Complete Controller’s team of certified US-based accounting professionals provide bookkeeping, record storage, performance reporting, and controller services including training, cash-flow management, budgeting and forecasting, process and controls advisement, and bill-pay. With flat-rate service plans, Complete Controller is the most cost-effective expert accounting solution for business, family-office, trusts, and households of any size or complexity.
