Financial Ratios A financial ratio (or accounting ratio) is a comparative expression (fraction) of two selected values taken from an enterprise’s financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm’s creditors. Security analysts use financial ratios to compare the strengths and weaknesses in various companies. Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Liquidity ratios measure the availability of cash to pay obligations to creditors and accrued expenses. Debt ratios measure the firm’s ability to repay long-term debt. Profitability ratios (ROI) measure the firm’s use of its assets and control of its expenses to generate an acceptable rate of return. These are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in company’s shares.
Financial ratios allow for comparisons
between companies
between industries
between different time periods for one company
between a single company and its industry average
Ratios generally hold no meaning unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition, are usually hard to compare.
Fixed Assets Assets that remain in the firm for periods of over one year, such as equipment, land and buildings, cars.
Income Statement or Profit and Loss Account Measures the difference between revenue (increase in assets) and expenses (decrease in assets) that has occurred during an accounting period.
Internal Rate of Return (IRR) Indicates the rate below which the investor will gain value by making the investment. Vice versa, above this rate the investor will lose value if the is carried out.
Interest Rate An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to the borrower. Interest rates are normally expressed as a percentage of the principal for a period of one year.
Liability An economic obligation (a debt) payable to an individual or an organisation outside the business.
Long-term Liabilities Claims payable in the medium to long term such as loans with a repayment schedule of more than one year.
Net Present Value (NPV) for a particular investment is the sum of the annual cash flows, revenues and costs, during the time horizon of the project, discounted to the date of the investment minus the investment outlay.
In other words Net Present Value of an investment is the present value of the stream of annual revenue (PVR) minus the annual stream of costs (PVC) after deducting the initial investment. The terms cost and operating expenses are used in the same context.
NPV = ((discounted future streams of revenues and costs) minus (initial Investment)) = (PV – Investment).
Net Worth Sometimes called net assets is total assets (TA) minus total outside liabilities (TL), Net Worth = TA – TL.
In the accounting equation: TA = TL + Equity → Equity = TA – TL thus net worth equals equity. As equity net worth is stated as at a particular year in time.
Pay Back Period In capital budgeting refers to the time required for the return on an investment to “repay” the sum of the original investment.
Present Value (PV) of either inflows or outflow of cash at a future date, as a result of the investment, is the discounted amount at the date of investment. This value is calculated using a discount factor that includes the market cost of capital plus the risk of investing in the firm. PV value factors equal to the investor’s cost of capital plus the project’s risk premium and will be obtained by the following procedure:
Revenue The receipt of cash or account receivables due to sales of a product or service.
Return on Initial Capital (ROIC) – Return on the initial investment or money used to start a business.
Stock Is the number of items carried as inventory. The firm must carry sufficient stock to satisfy its demand. Too little stock may have a negative effect on the sales ability and the relationship with customers. Too much stock ties up funds unnecessarily. Stock is a current asset.
Statement of Cash Flows Describes how the business has generated and used cash during the accounting period.
Statement of Changes in Equity Shows the effect of certain transactions on the value of the equity of the owners.
“What If” Analysis or Simulation Business simulation is simulation used for business training or analysis. It can be scenario-based or numeric-based. Most business simulations are used for business acumen training and development. Learning objectives include: strategic thinking, financial analysis, market analysis, operations, teamwork and leadership. The business gaming community seems lately to have adopted the term business simulation game instead of just gaming or just simulation. The word simulation is sometimes considered too mechanistic for educational purposes. Simulation also refers to activities where an optimum for some problem is searched for, while this is not usually the aim of an educational game. On the other hand, the word game can imply time wasting, not taking things too seriously and engaging in an exercise designed purely for fun. The concept of simulation gaming seems to offer the right combination and balance between the two. Simulation gaming is also the term that the educational gaming community has adopted.