So, you want to get a handle on how businesses are really doing? Forget the fancy jargon for a second. We’re talking about financial ratios. Think of them as a translator for all those numbers in a company’s reports. They take complex financial statements and boil them down into simple comparisons. This helps you see if a company is making money, can pay its bills, or is buried in debt. It’s like a health check for your finances, really. We’ll break down the different types of financial ratios and what they actually mean for a business.
Key Takeaways
- Financial ratios help simplify complex financial statements into understandable comparisons.
- Different ratios measure a company’s profitability, its ability to meet short-term debts (liquidity), and its long-term financial stability (solvency).
- Efficiency ratios show how well a company uses its assets and manages its operations.
- Valuation ratios help investors gauge a company’s stock price relative to its earnings or book value.
- Analyzing trends and comparing ratios against industry averages provides deeper insights than looking at numbers in isolation.
Understanding Financial Ratios
Defining Financial Ratios
Financial ratios are basically calculations that use numbers from a company’s financial statements to give you a clearer picture of how it’s doing. Think of them as diagnostic tools. They take different pieces of information – like profits, debts, or assets – and put them together in a way that makes them easier to compare and understand. These ratios help us see trends and performance over time. They’re not just for accountants; investors, lenders, and even the company’s own managers use them to make decisions. They help answer questions like: Can the company pay its bills? How much debt does it have? Is it making money efficiently?
The Role of Financial Ratios in Analysis
So, why bother with ratios? Well, raw numbers from financial statements can be a bit overwhelming. Ratios simplify things. They allow for comparisons that would be difficult otherwise. You can compare a company’s performance this year to last year, or you can compare it to other companies in the same industry. This helps you spot strengths, weaknesses, and potential problems before they get too big. They provide a standardized way to look at a company’s financial health and operational effectiveness. Without them, assessing a business’s true standing would be much harder, relying more on gut feelings than solid data. They are a key part of any good financial analysis.
Key Components of Financial Statements
To calculate and understand financial ratios, you first need to know where the numbers come from. The main financial statements are:
- Income Statement: This shows a company’s revenues, expenses, and profits over a specific period (like a quarter or a year). It tells you if the company is making money.
- Balance Sheet: This provides a snapshot of a company’s assets, liabilities, and owner’s equity at a specific point in time. It shows what the company owns and what it owes.
- Cash Flow Statement: This tracks the movement of cash both into and out of the company over a period. It’s important because a company can be profitable on paper but still run out of cash.
Understanding these three statements is the first step before you can even begin to calculate and interpret any financial ratios.
Profitability Financial Ratios
Profitability ratios are like the report card for a business. They tell you how well a company is actually making money from its operations. It’s not just about bringing in sales; it’s about how much of that sales revenue actually sticks around as profit after all the costs are paid. These ratios are super important for investors trying to figure out if a company is a good bet, and for managers who need to see if their strategies are working.
Gross Profit Margin
This one looks at the profit a company makes directly from selling its goods or services, before considering other operating expenses like marketing or administrative costs. It’s calculated by taking the gross profit (revenue minus the cost of goods sold) and dividing it by the revenue. A higher gross profit margin generally means the company is efficient at producing its goods or managing its direct costs.
Formula: Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue
Operating Profit Margin
Moving a step further, the operating profit margin shows how much profit a company makes from its core business operations. It takes into account not just the cost of goods sold, but also operating expenses like salaries, rent, and marketing. This ratio gives a clearer picture of the company’s operational efficiency. A strong operating profit margin suggests the company is managing its day-to-day business effectively.
Formula: Operating Profit Margin = Operating Income / Revenue
Net Profit Margin
This is the bottom line, literally. The net profit margin shows the percentage of revenue that remains as profit after all expenses, including taxes and interest, have been deducted. It’s the most comprehensive measure of profitability. A healthy net profit margin indicates that the company is not only good at generating sales and managing operations but also at controlling all its costs, including financing and taxes. It’s a key indicator for overall financial health.
Formula: Net Profit Margin = Net Income / Revenue
Understanding these profitability ratios helps paint a picture of a company’s earning power. They are essential for comparing performance over time and against competitors. Without looking at these, you’re really just guessing about how well a business is doing financially.
Profitability isn’t just about making sales; it’s about how much of those sales turn into actual profit after all expenses are accounted for. This is what truly shows a company’s ability to generate wealth for its owners and reinvest in its future.
Liquidity Financial Ratios
When we talk about a company’s ability to pay its bills, especially the short-term ones, we’re really getting into liquidity. It’s like checking if you have enough cash in your wallet to cover your immediate expenses, not just your long-term debts. A company needs to have enough readily available funds to keep its day-to-day operations running smoothly. Without enough liquidity, even a profitable company can run into serious trouble, sometimes called a liquidity crisis. This is where liquidity ratios come in handy.
These ratios help us get a snapshot of a company’s short-term financial health. They look at a company’s current assets – things it can turn into cash within a year – and compare them to its current liabilities – debts due within a year. Think of it as a quick check on whether the company can meet its immediate obligations without having to sell off long-term assets at a loss.
Current Ratio
The current ratio is probably the most straightforward liquidity measure. It simply compares a company’s total current assets to its total current liabilities. A higher ratio generally suggests a better ability to meet short-term obligations.
Formula:
Current Ratio = Current Assets / Current Liabilities
For example, if a company has $200,000 in current assets and $100,000 in current liabilities, its current ratio would be 2.0. This means it has $2 in current assets for every $1 of current liabilities.
Quick Ratio
Sometimes, a company might have a lot of current assets, but a big chunk of that could be inventory, which isn’t always easy to sell quickly without a discount. The quick ratio, also known as the acid-test ratio, refines the current ratio by excluding inventory from current assets. It focuses on the more liquid assets – cash, marketable securities, and accounts receivable.
Formula:
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Or, more precisely:
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
A quick ratio of 1.0 or higher is often considered healthy, indicating the company can cover its short-term debts without relying on selling inventory.
Cash Ratio
This is the most conservative liquidity ratio. The cash ratio looks only at a company’s most liquid assets – cash and cash equivalents – and compares them to its current liabilities. It tells you how well a company can pay off its short-term debts using only the cash it has on hand or can access immediately.
Formula:
Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities
A high cash ratio means the company has a strong immediate ability to pay its bills, but it could also mean the company isn’t investing its cash effectively to generate higher returns.
Understanding these ratios is key to assessing a company’s short-term financial stability. While a healthy ratio is good, it’s also important to look at the trends over time and compare them to industry averages. A sudden drop in liquidity could signal upcoming problems, even if the company looks fine on the surface.
Solvency Financial Ratios
When we talk about a company’s long-term financial health, solvency ratios are what we’re looking at. These ratios help us figure out if a business has enough assets to cover all its debts, not just the ones due soon, but the ones that are due way down the line. It’s like checking if you have enough savings to pay off your mortgage and other big loans, not just your credit card bill.
Debt-to-Equity Ratio
This is a pretty common one. The debt-to-equity ratio compares a company’s total liabilities to its shareholder equity. Basically, it tells you how much debt a company is using to finance its assets relative to the amount of value represented by shareholders’ ownership. A high ratio might mean a company is using a lot of debt, which can be risky.
- Formula: Total Liabilities / Total Shareholder Equity
- Interpretation: A ratio above 1.0 means the company has more debt than equity. A ratio below 1.0 suggests it has more equity than debt.
Debt-to-Assets Ratio
Similar to the debt-to-equity ratio, this one looks at how much of a company’s assets are financed through debt. It gives you a sense of how much the company owes compared to what it owns. A higher ratio means more assets are funded by borrowing.
- Formula: Total Liabilities / Total Assets
- Interpretation: A ratio of 0.5, for example, means that 50% of the company’s assets are financed by debt.
Interest Coverage Ratio
This ratio is all about a company’s ability to pay the interest on its outstanding debt. It measures how many times a company’s earnings before interest and taxes (EBIT) can cover its interest expenses. A higher ratio is generally better, showing the company has a good cushion to meet its interest payments.
- Formula: Earnings Before Interest and Taxes (EBIT) / Interest Expense
- Interpretation: A ratio of 3 means the company’s operating income is three times greater than its interest obligations.
Solvency is about a company’s ability to survive over the long haul. It’s not just about having enough cash today, but about having a solid financial foundation that can withstand economic ups and downs and meet all its financial commitments, both near and far. A company that can’t pay its long-term debts is in serious trouble, no matter how profitable it looks on paper.
These ratios are super important for lenders and investors trying to gauge the financial stability of a business. They help paint a picture of the company’s risk profile and its capacity to manage its financial obligations over the long term. Understanding these metrics is key to assessing the overall financial health of an organization, going beyond just its day-to-day operations. You can find more on financial health indicators to get a broader view.
Efficiency Financial Ratios
Efficiency ratios are all about how well a company uses its assets and manages its liabilities to generate sales and profits. Think of it like this: if a company has a lot of fancy equipment (assets), but it’s not producing much in the way of goods or services (sales), then it’s not being very efficient. These ratios help us see how smoothly operations are running.
Inventory Turnover Ratio
This ratio tells you how many times a company sells and replaces its inventory over a specific period. A high turnover usually means sales are strong, and inventory isn’t sitting around collecting dust. A low turnover might suggest weak sales or too much stock on hand. It’s calculated by dividing the Cost of Goods Sold by the Average Inventory.
Accounts Receivable Turnover
This one measures how effectively a company collects the money owed to it by customers. It shows how many times a company collects its average accounts receivable during a period. A higher turnover generally indicates that a company is collecting its debts quickly, which is good for cash flow. The formula is Net Credit Sales divided by Average Accounts Receivable.
Asset Turnover Ratio
This ratio looks at how well a company uses its total assets to generate sales. It’s a broad measure of efficiency. A higher asset turnover ratio means the company is generating more sales for every dollar of assets it owns. The calculation is simply Net Sales divided by Average Total Assets.
These ratios are particularly useful when comparing a company to its past performance or to others in the same industry. What’s considered ‘good’ can really depend on the business type. For example, a grocery store will likely have a much higher inventory turnover than a car dealership.
Here’s a quick look at how these are calculated:
- Inventory Turnover Ratio: Cost of Goods Sold / Average Inventory
- Accounts Receivable Turnover: Net Credit Sales / Average Accounts Receivable
- Asset Turnover Ratio: Net Sales / Average Total Assets
Valuation Financial Ratios
Valuation ratios are like the scorecards for how the market sees a company’s worth. They help investors figure out if a stock is a good deal or if it’s overpriced. It’s not just about how much money a company makes right now, but also about what people think it’s worth in the future. These ratios compare a company’s stock price to its financial performance or book value.
Price-to-Earnings Ratio
The Price-to-Earnings (P/E) ratio is probably the most talked-about valuation metric. It’s pretty straightforward: you take the current market price of a company’s stock and divide it by its earnings per share (EPS). So, if a stock is trading at $50 and its EPS is $5, the P/E ratio is 10. This means investors are willing to pay $10 for every $1 of earnings the company generates. A high P/E might suggest investors expect higher growth in the future, or it could mean the stock is expensive. A low P/E could signal an undervalued stock or that the company faces challenges.
- Formula:
Market Price per Share / Earnings per Share (EPS) - Interpretation: A P/E of 10 means investors pay $10 for $1 of earnings.
- Considerations: Compare P/E ratios within the same industry, as different sectors have different norms.
Price-to-Book Ratio
Next up is the Price-to-Book (P/B) ratio. This one compares a company’s stock price to its book value per share. Book value is essentially what would be left for shareholders if a company sold all its assets and paid off all its debts. It’s a measure of a company’s net worth on its balance sheet. A P/B ratio below 1 might indicate that the stock is trading for less than its liquidation value, which could be a bargain. However, it can also mean the company has significant problems or its assets are overvalued on the books.
- Formula:
Market Price per Share / Book Value per Share - Book Value per Share:
(Total Assets - Total Liabilities) / Number of Outstanding Shares - Significance: Useful for asset-heavy industries like manufacturing or banking.
Dividend Yield
For investors who are looking for income, the Dividend Yield is key. This ratio shows how much a company pays out in dividends each year relative to its stock price. It’s expressed as a percentage. A higher dividend yield means you’re getting more income for every dollar invested in the stock. However, a very high yield can sometimes be a warning sign, perhaps indicating that the stock price has fallen significantly because the company is in trouble, and the dividend might be cut.
- Formula:
Annual Dividends per Share / Market Price per Share - Example: If a stock pays $2 in annual dividends and trades at $40, the dividend yield is 5%.
- Focus: Primarily for income-focused investors.
Valuation ratios are not crystal balls. They provide a snapshot and a point of comparison, but they don’t tell the whole story. Always use them alongside other financial metrics and consider the company’s overall business strategy and industry trends before making any investment decisions.
Leverage Financial Ratios
Leverage ratios are all about how much debt a company uses to fund its operations. Think of it like using a lever to lift something heavy – a little effort can move a big object. In finance, that ‘effort’ is debt, and the ‘object’ is the potential for higher returns on the money invested. It’s a powerful tool, but you’ve got to be careful not to overdo it.
Understanding Financial Leverage
Basically, financial leverage means using borrowed money to increase the potential return on an investment. Companies can borrow money from banks, issue bonds, or use other forms of debt. When a company uses debt effectively, it can boost its profits beyond what it could achieve with just its own money. However, this also means that if things go south, the losses can be amplified just as much. It’s a double-edged sword, really. The key is finding that sweet spot where the benefits of borrowing outweigh the risks.
- Debt-to-Equity Ratio: This is a big one. It compares a company’s total liabilities to its shareholder equity. A higher ratio means the company is using more debt relative to equity, indicating higher financial risk. A ratio of 1.0, for instance, suggests that creditors and owners have provided equal amounts of capital.
- Debt-to-Assets Ratio: This ratio shows the proportion of a company’s assets that are financed through debt. A higher percentage means more assets are funded by borrowing, which again, points to increased risk.
- Interest Coverage Ratio: This one is pretty straightforward. It measures a company’s ability to make its interest payments on outstanding debt. A higher ratio means the company has a better cushion to cover its interest expenses, which is good news for lenders.
Impact of Leverage on Returns
When a company borrows money at a lower interest rate than the return it earns on its investments, the difference goes straight to the shareholders, increasing the return on equity. This is the upside of using financial leverage. For example, if a company borrows at 5% and earns 10% on that borrowed money, the extra 5% benefits the owners. This can make a company’s stock look more attractive. However, if the company earns less than its borrowing cost, or if revenues decline, the fixed interest payments become a heavy burden, eating into profits and potentially leading to losses.
Managing Leverage Risks
Managing the risks associated with financial leverage is super important for long-term stability. Too much debt can make a company vulnerable to economic downturns or rising interest rates. Lenders often impose covenants – rules that the company must follow, like maintaining certain financial ratios. Breaking these covenants can lead to penalties or even force the company to repay its debt immediately. So, companies need to be smart about how much debt they take on and ensure they can comfortably meet their obligations. It’s all about balancing growth opportunities with financial safety. A good starting point for understanding this balance is to look at corporate finance principles.
Here are some key considerations for managing leverage risks:
- Monitor Debt Levels: Regularly assess the company’s debt-to-equity and debt-to-assets ratios against industry averages and historical trends.
- Assess Interest Rate Sensitivity: Understand how changes in interest rates could impact the cost of servicing debt and overall profitability.
- Maintain Strong Cash Flow: Ensure consistent and sufficient cash flow to cover interest payments and principal repayments, even during slower periods.
- Diversify Funding Sources: Avoid over-reliance on a single type of debt or lender to reduce dependency and improve flexibility.
The strategic use of debt can accelerate growth and improve shareholder returns, but it introduces financial fragility. Companies must carefully balance the benefits of borrowing against the increased risk of default and the constraints imposed by lenders. Prudent management involves continuous monitoring of debt levels, interest coverage, and overall economic conditions to ensure that leverage remains a tool for value creation rather than a source of distress.
Cash Flow Financial Ratios
When we talk about a company’s financial health, we often hear about profits. But profits on paper don’t always mean there’s actual cash in the bank. That’s where cash flow ratios come in. They help us understand how well a company is managing the money coming in and going out. Think of it like your own checking account – you might have a good salary, but if your bills are due before your paycheck clears, you’re in trouble. The same applies to businesses.
These ratios are super important because they show a company’s ability to pay its bills, fund its operations, and invest in the future using the cash it actually generates. It’s one thing to say you’re profitable, but it’s another thing to show you have the cash to back it up. This is especially true for growing companies, which can sometimes look good on paper but run out of cash because they’re investing so much in new inventory or equipment.
Operating Cash Flow Ratio
This ratio tells us how well a company’s day-to-day business operations are generating enough cash to cover its short-term liabilities. It’s a good indicator of the quality of a company’s earnings. A higher ratio generally means the company is doing a solid job of turning its sales into cash.
Formula:
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
Free Cash Flow Analysis
Free cash flow (FCF) is the cash a company has left over after paying for its operating expenses and capital expenditures (like buying new machinery or buildings). It’s the cash that’s truly available to the company to pay down debt, pay dividends to shareholders, or reinvest in the business for future growth. Analyzing FCF helps you see if a company is generating enough cash to do all these important things.
- Positive FCF: Generally a good sign, indicating the company has cash available for various purposes.
- Negative FCF: Might mean the company is investing heavily in growth, or it could signal trouble if it’s persistent and not tied to strategic investments.
Cash Flow to Debt Ratio
This ratio measures how well a company can pay off its debts using the cash generated from its operations. It’s a key metric for lenders and investors looking at a company’s ability to manage its debt load. A higher ratio suggests the company has a stronger capacity to meet its debt obligations.
Formula:
Cash Flow to Debt Ratio = Operating Cash Flow / Total Debt
Understanding these cash flow ratios is vital because they provide a clearer picture of a company’s financial stability than profit figures alone. They highlight the actual cash movements, which are the lifeblood of any business, allowing it to operate, grow, and weather financial storms.
Interpreting Financial Ratios
So, you’ve calculated a bunch of financial ratios. That’s great, but what do they actually mean? Just having the numbers isn’t enough; you need to know how to make sense of them. It’s like having all the ingredients for a cake but not knowing the recipe. We need to look at these ratios in a few different ways to get a real picture of a company’s health and performance.
Trend Analysis
This is all about looking at a company’s ratios over time. Are they getting better, worse, or staying about the same? For example, if a company’s current ratio was 2.0 last year and is now 1.5, that’s a downward trend. It might mean they’re having more trouble paying short-term bills. You’d want to see a consistent or improving trend for most ratios. It helps you spot potential problems before they become big issues.
Here’s a quick look at what you might track:
- Profitability: Is net profit margin increasing or decreasing?
- Liquidity: Is the current ratio stable or declining?
- Solvency: Is the debt-to-equity ratio going up or down?
- Efficiency: Is inventory turnover speeding up or slowing down?
Industry Benchmarking
Comparing a company’s ratios to others in the same industry is super important. A debt-to-equity ratio of 1.0 might be normal for a utility company, but really high for a software company. You need to know what’s typical for that specific business sector. This helps you see if the company is performing better or worse than its peers. It’s like comparing your race times to other runners in your age group – you need the right comparison group.
Here’s a simplified example:
| Ratio | Company A | Industry Average | Company B |
|---|---|---|---|
| Gross Profit Margin | 45% | 40% | 50% |
| Current Ratio | 1.8 | 2.2 | 1.5 |
| Debt-to-Equity Ratio | 0.7 | 0.9 | 1.2 |
In this snapshot, Company A looks pretty good on profitability and debt, but maybe a bit weak on liquidity compared to the average. Company B is strong on profit but has higher debt and lower liquidity.
Limitations of Financial Ratios
Now, it’s not all perfect. Ratios are useful, but they have their limits. They’re based on historical data, so they don’t predict the future perfectly. Different accounting methods can make comparisons tricky. Also, a single ratio rarely tells the whole story; you need to look at them together. And sometimes, companies can manipulate numbers to make ratios look better than they are. Always use ratios as a starting point for deeper investigation, not as the final word.
- Ratios are backward-looking.
- Accounting differences can skew comparisons.
- They don’t capture qualitative factors like management quality or brand reputation.
- Industry averages can sometimes be misleading if the industry itself is struggling or undergoing rapid change.
Understanding financial ratios is a skill that develops with practice. It involves looking beyond the raw numbers to understand the underlying business activities and economic conditions. Combining trend analysis with industry benchmarks provides a more robust perspective, but always keep the inherent limitations in mind to avoid drawing incorrect conclusions.
Strategic Application of Financial Ratios
So, you’ve spent time crunching numbers, calculating all sorts of ratios – profitability, liquidity, solvency, you name it. Now what? It’s not just about having the numbers; it’s about using them to actually do something. That’s where the strategic application comes in. Think of these ratios as your company’s vital signs. Just like a doctor uses your pulse and blood pressure to understand your health, you use financial ratios to understand your business’s health and make smart decisions.
Investment Decision Making
When you’re looking to invest, whether it’s your own money or a company’s capital, ratios are your first stop. They help you figure out if a business is a good bet. For instance, a consistently high Return on Equity (ROE) might signal a company that’s good at making money for its shareholders. On the flip side, a company with a sky-high Debt-to-Equity ratio might be too risky, even if its profits look good on paper. You want to find that sweet spot where a company is growing, profitable, and not drowning in debt. It’s about spotting opportunities and avoiding potential pitfalls before you commit any funds. This is where understanding capital allocation becomes really important.
Creditworthiness Assessment
If you’re a lender, or even if you’re just a supplier who offers credit terms, you need to know if the company you’re dealing with can actually pay you back. Financial ratios are key here. Lenders will look closely at your liquidity ratios, like the Current Ratio and Quick Ratio, to see if you have enough short-term assets to cover your short-term debts. They’ll also examine solvency ratios, such as the Debt-to-Assets Ratio, to gauge your long-term financial stability. A strong set of ratios suggests a lower risk of default, making it easier to secure loans or favorable credit terms. It’s all about building trust and demonstrating financial responsibility.
Performance Management
Internally, financial ratios are invaluable for tracking how the business is doing over time and against its peers. Are your sales growing faster than your expenses? Your profit margins will tell you. Are you managing your inventory efficiently? The Inventory Turnover Ratio will give you the answer. Setting targets for these ratios and monitoring them regularly allows management to identify areas that need attention.
Here’s a quick look at how different ratios can guide performance:
- Profitability Ratios: Track if the company is making money from its operations. Are gross, operating, and net profit margins improving?
- Efficiency Ratios: Measure how well the company is using its assets to generate sales. Is inventory moving quickly? Are customers paying their bills on time?
- Liquidity Ratios: Show the company’s ability to meet its short-term obligations. Can it pay its bills next month?
Regularly comparing your company’s ratios against industry averages, often found through services that analyze financial systems and institutions, provides a reality check. It helps you understand if you’re a leader, a laggard, or somewhere in between, guiding strategic adjustments to stay competitive.
Wrapping Up: Making Sense of the Numbers
So, we’ve gone through a bunch of financial ratios. It might seem like a lot of numbers and formulas at first, and honestly, it can be. But the main idea is pretty straightforward: these ratios help us get a clearer picture of how a business is doing. They’re like tools that let us compare companies, see trends over time, and spot potential problems or strengths. Using them isn’t about finding some magic answer, but more about asking better questions and making more informed decisions, whether you’re running a business, investing, or just trying to understand the financial world a little better. Keep practicing, and these numbers will start to make more sense.
Frequently Asked Questions
What exactly are financial ratios and why do we use them?
Think of financial ratios as special math problems that use numbers from a company’s financial reports. They help us understand how well a company is doing. It’s like checking a report card for a business to see if it’s good at making money, paying its bills, or managing its stuff.
How do profitability ratios help us know if a company is making money?
Profitability ratios are like a score for how much money a company keeps after paying for everything it needs to run. Ratios like ‘Gross Profit Margin’ show how much is left after just the cost of making the product. ‘Net Profit Margin’ shows what’s left after all costs, including taxes and interest, which gives a clearer picture of the real profit.
What does a company’s ‘Current Ratio’ tell us?
The Current Ratio is a quick check to see if a company has enough easily available money or things it can quickly turn into money (like money in the bank or money owed by customers) to pay off its short-term debts (bills due soon). A higher number generally means it’s safer.
How can we tell if a company is good at managing its debts?
Solvency ratios, like the ‘Debt-to-Equity Ratio,’ help us see how much a company relies on borrowing money compared to the money owners have put in. If a company owes a lot more than it owns, it might be risky, especially if times get tough.
What’s the point of ‘Inventory Turnover Ratio’?
This ratio shows how quickly a company is selling its products or ‘inventory.’ A high turnover means products are flying off the shelves, which is usually good because it means the company isn’t stuck with old stock. A low turnover might mean things aren’t selling well.
Can you explain the ‘Price-to-Earnings Ratio’ in simple terms?
The P/E ratio compares a company’s stock price to its earnings (the money it makes). It helps investors decide if a stock is a good deal. If the P/E is high, it might mean investors expect the company to grow a lot in the future, or it could mean the stock is a bit expensive right now.
What is ‘Financial Leverage’ and is it always good?
Financial leverage is basically using borrowed money to try and make more profit. It can be great when things are going well, as it can boost how much money owners make. But, it’s like a double-edged sword – if things go badly, the losses can also be much bigger.
Why is ‘Cash Flow’ so important, maybe even more than profit?
Profit on paper doesn’t always mean a company has actual cash in hand. Cash flow is about the real money coming in and going out. A company can look profitable but still run out of cash if customers don’t pay on time or if it has too many bills due. Managing cash flow is key to staying in business.