Financial Performance: Ratios

The Income Statement, Balance Sheet and Cash Flow Statements numbers are important to see the size of the business in which a comapny is making money, but absolute numbers are not really useful to compare different companies’ performance among eachother. Instead of that, the ratios are used to analyse and compare performance because they show the relation of the numbers between each other.

There are as many possible ratios as combination of financial numbers can be, but I have chosen 15 of them to use in the financial performace reviews of this section because of what they say about the companies. It is not my intention to deliver a deep analysis on this topic, for that objective there are plenty of professional financial analysts that do this with much more in detail than what I do here. However, I want to include in a short and clear analysis of relevant companies to know their relative financial position and strength against each other, which will serve to understand many other strategic decisions or positions in further strategy analyses. You can find those ratios in the table below and see the image in full size by clicking on it.



Profitability ratios (1 to 7)

These ratios can be divided in two groups: Return ratios (1 to 4) and margin ratios (5 to 7). The former group of ratios is used to define how efficient is the use of funds in returning wealth, and the latter is used to know how much profit is the company making at different points of the whole operation. Those ratios that use EAT tell us how much is returning after all operational, administrative, financial and any other possible income or expense, it is what the shareholders will see at the end of the day. Those ratios using EBIT do not consider financial, taxes or any other income or expenses, is just what is left after producing and selling (managing) the product, including variable and fixed costs. When EBITDA is used is only considering the costs of producing the good. For all the profitability ratios, the closer the ratio is to 100%, the better.


Efficiency ratios (8 and 9)

These ratios are to show how much in sales are the capital investment and the assets generating, without considering any expenses. This is not to define how efficient the company is operating (for that are in the profitability ratios), but to understand how much the company is selling in proportion with the capabilities it has. Again a 100% is desirable, but it could be higher.


Liquidity ratios (10 to 12)

These ratios are useful as indicators of financial health of a company. There are many reasons why they could look too good or too bad for the real company’s situation, and by themselves should not be taken as definitive yes or no flag. However, they are great “heads’up” signals to decide whether to look closer into the company. The three of them measure how capable is the company to fulfil its short term obligations (debt) under different circumstances. The desirable value of these ratios may be different depending on the industry, but for now I took standard values that may change as we analyse more and more technology companies further.


Gearing ratios (13 to 15)

The gearing ratios serve to measure the level of debt with which the company has made a commitment. This debt is the long term liabilities and it is an alternative of Equity when the cost of equity is too high, or equally, when the cost of debt is too low. Especially in the ratio number 13, in general a ratio higher than 30% is not desirable, however it again depends on the industry and we will learn what the average gearing ratio of technology companies is as we go further in the performance analysis of more companies.

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