The financial indicators or financial indices are the relationships between economic and financial statistics, such as debt, assets, liabilities, equity, income and production. Its usefulness lies in its ability to provide an idea about the strength, stability and performance of various sectors of an organization.
For example, an analysis of the debt of a company alone does not provide as much information as the analysis of the cost of debt in relation to income, or the level of debt in relation to net worth.
The use of financial indicators to measure the performance of a company makes it possible to compare different types of businesses. If you are looking to compare your company's performance with a wide variety of other companies, financial indicators are a neutral tool for evaluating performance.
There is no substitute for financial indicators when it comes to measuring the financial health of a business. Closely monitoring the financial performance of a business is essential to its long-term success.
Main financial indicators and their characteristics
Working capital
Assessing the health of a company in which you want to invest involves understanding its liquidity. Understand how easily that company can convert assets to cash to pay its short-term obligations.
The working capital indicator is calculated by dividing current assets by current liabilities.
For example, if company XYZ has current assets of $ 8 million, and current liabilities of $ 4 million, it has a 2-to-1 ratio, which sounds great.
Additionally, if two similar companies have a 2-to-1 ratio, but one has more cash in its current assets, that company could pay its debts faster than the other.
Quick ratio
Also called the acid test, this indicator subtracts inventories from current assets, before dividing that figure by current liabilities.
The idea is to show how well current liabilities are covered by cash and items with a near cash value. Inventory, on the other hand, takes time to sell and become a liquid asset.
If XYZ has $ 8 million in current assets minus $ 2 million in inventory, over $ 4 million in current liabilities, it has a 1.5-to-1 ratio. Companies like to have at least a 1-to-1 ratio.
The resulting number should ideally be between 1.5 and 3. A ratio of less than 1 means that you don't have enough cash to pay bills in the short term.
Tracking this indicator can give early warning of cash flow problems, especially if the ratio falls into the danger zone between 1.5 and 1.
Earnings per share
By buying a share, you are participating in the future profit (or risk of loss) of the company. Earnings per share measures the net income obtained by each share, within the common shares of a company.
The company's analysts divide its net income by the weighted average number of common shares outstanding during the year.
Price-earnings ratio
Called P / G for short, this indicator reflects investors' assessment of future earnings. The price of the company's shares is determined and divided by the earnings per share, to obtain the price-earnings ratio.
For example, if a company closed at $ 46.51 per share and earnings per share for the last twelve months averaged $ 4.90, then the P / E ratio would be 9.49. Investors would have to spend $ 9.49 for every dollar that is generated in annual earnings.
Still, investors have been willing to pay more than 20 times earnings per share for certain stocks. This is in case they feel that future earnings growth provides an adequate return on their investment.
Debt ratio
What if a company in which you want to make a potential investment is borrowing too much? This can lower the safety margins behind what you owe, increase your fixed charges, lower the earnings available for dividends, and even cause a financial crisis.
The debt ratio is calculated by adding the outstanding short-term and long-term debt, and dividing it by the book value of stockholders' equity.
Let's say XYZ has roughly $ 3.1 million in loans and equity of $ 13.3 million. That generates a modest debt ratio of 0.23, which is quite acceptable in most circumstances.
However, as with all other indicators, the metric should be analyzed in terms of industry standards and specific company requirements.
Return on capital
Common shareholders want to know how profitable their capital is in the businesses in which they invest.
Return on equity is calculated by taking the company's net earnings (after taxes), subtracting dividends, and dividing the result by the value of the company's common stock.
Let's say the net earnings are $ 1.3 million and the dividends are $ 300,000. Subtract this and divide by the $ 8 million in common stock. This gives a return on equity of 12.5%.
The higher the return on equity, the better the company is at generating profit.
Gross profit margin
The gross profit margin indicates whether the goods or services are being priced appropriately. Here is the equation to calculate this financial indicator:
Gross profit margin = (revenue - cost of merchandise sold) / revenue.
The gross profit margin should be large enough to cover the fixed operating expenses and leave a net profit margin at the end.
Net profit margin
The net profit margin indicates what percentage of the income was a profit. The equation is simple: Net Profit Margin = Net Profit / Total Income.
Net profit is the amount of money left after all the bills have been paid. Net profit can be calculated using a simple subtraction:
Net profit = total income - total expenses
For example, if last year's sales totaled $ 100,000 and business expenses for rent, inventory, wages, etc. totaled $ 80,000, the net profit is $ 20,000.
This indicator helps project future earnings and set goals and benchmarks for profitability.
