Financial measures include ratios such as profitability ratios, liquidity ratios, efficiency, and leverage ratios. Profitability ratios can be said to be the evaluation methods. Profit is the main aim for every organization and therefore the profit ratio aid in judging the achievement of an organization in terms of profits. It involves the evaluation of two major types which include profit margin and rate of return ratio. The profit margin evaluation involves the analysis of the gross profit margin (Delen, 2019). The rate of return ratio encompasses the return on equity, return on asset, etc.
Liquidity Ratios are another measure of the liquidity of an organization. These are calculated to determine the organizational liquidity position. The term liquidity can be defined as the ability of the organization to pay its obligations. An organization with unstable liquidity is likely to be bankrupt. The liquidity ratio is done by using current assets and organizational liabilities. Some of the important liquidity ratios include the current ratio, acid test quick ratio, and so forth.
Leverage Ratios are hard to determine especially in an organization that has no debt and capital structure. The use of organizational debt in the capital structure is what has been termed as leverage. Leverage ratio surrounds the organizational debt. In leverage ratio, two types of ratios can be determined coverage ratio and the capital structure ratios (Delen, 2019). The capital structures ratio can be used by the financial analysts in determining the risks of the bankruptcy of an organization, the servicing capacity in terms of payment by making comparisons with future debt obligations with the resources used. These ratios include Debt equity ratio and the debt asset ratio
Efficiency Ratios are the financial measures that judge the efficiency in the management of the assets. Since organizations use assets to generate sales these ratios aid in evaluating the asset to efficiently generate or convert the available assets into sales.
Financial measures such as ratio play a critical role as financial analysts use it to determine the financial condition of an organization by comparing the line item data from the finical statement to get insights regarding the organizational profitability, liquidity as well as operational solvency of the organization (Lau & Sholihim, 2015). Financial analysts use the ratios to mark the firm performance over a given time by doing the comparison with other organizations or firms under the same sector or industry.
Delen, D., Kuzey, C., & Uyar, A. (2019). Measuring firm performance using financial ratios: A decision tree approach. Expert systems with applications, 40(10), 3970-3983.
Lau, C. M., & Sholihin, M. (2005). Financial and non-financial performance measures: How do they affect job satisfaction?. The British Accounting Review, 37(4), 389-413.
Financial efficiency measures the degree of efficiency in using labor, management, and capital. Financial KPI’s (Key Performance Indicators) are metrics organizations which are used to track, measure, and analyze the financial health of the company, and these financial KPIs fall under a variety of categories, including profitability, liquidity, solvency, efficiency, and valuation. The financial performance can be analyzed by external and internal stakeholders to evaluate business performance and value from the financial statement analysis where the financial statement analysis is mainly taken into consideration with the help of Balance sheet, Income statement, and cash flow (Contributor, 2020).
The Profitability ratios are classified into two types as Margin ratios and Return ratios. The Margin ratios are Gross Profit margin, EBITDA, Operating Profit, Net Profit, and Cash flow. The Return ratios are Return on Assets, Return on Invested Capital, and Return on Equity. The Liquidity ratios give an idea about the company’s ability to convert its assets into cash and pay its current liabilities with that cash whenever required. The Liquidity ratios are the Current ratio, Quick ratio, Cash ratio, and Defensive Interval ratio. The five measures of financial efficiency are the asset turnover ratio, operating expense ratio, depreciation expense ratio, interest expense ratio, and net farm income from operations ratio. The solvency ratio is a key metric used to measure an enterprise’s ability to meet its long-term debt obligations and is used often by prospective business leaders. The three types of solvency ratios are Debt-to-equity ratios, Total-debt-to-total-asset ratios, and Interest coverage ratios. A valuation ratio shows the relationship between the market value of a company or its equity and some fundamental financial metric. Some of the valuation ratios are Price-to-earnings, Price-to-book value, Price-to-sales, Price-to-cash-flow, Price/earnings-to-growth (PEG) ratios (Carlson, (n.d.)).
The profitability of a company influences its value and the amount of income it generates for its owners. The profitability ratio can be used to determine the company’s bottom line for its managers and its return on equity to its investors and moreover the profitability ratios are important for company managers in a corporation. The management should have to measure the profitability ratio to know how to steer the business in the right direction (Maverick, 2020). Moreover, the company is responsible to show the profitability for the investors who are outside of the business and purchased the stock as the company management should share all this information to those equity investors.
If the Gross profit margin is less than 40% then it is considered as Competition eroding margins. With the help of Return on Equity (ROE) ratio, investors distinguish whether the company is a profit creator or profit burner, and with the help of Kellogg’s company Return on Equity ratio in the recent quarter, investors see the growth in the company and consider it as a profit creator (Maverick, 2020).
Carlson, R. (n.d.). What You Should Know About Profitability Ratio Analysis. Retrieved December 08, 2020, from https://www.thebalancesmb.com/profitability-ratio-analysis-393185
Contributor, C. (2020, November 04). How to Measure Business Performance With Financial Indicators. Retrieved December 08, 2020, from https://smallbusiness.chron.com/measure-business-performance-financial-indicators-64819.html
Maverick, J. (2020, August 28). The Difference Between Gross Profit Margin and Net Profit Margin. Retrieved December 08, 2020, from https://www.investopedia.com/ask/answers/021215/what-difference-between-gross-profit-margin-and-net-profit-margin.asp