Financial performance ratios 1 Financial Performance Ratios Financial

Financial performance ratios 1

Financial Performance Ratios • Financial performance ratios are comparisons using a company’s financial data to determine how well a business is performing. • The four main types of financial ratios: – Current ratio – Debt to equity ratio – Return on equity ratio – Net income ratio 2

Financial Performance Ratios continued • Current ratio – Equals current assets/current liabilities – Represents assets that the business could convert into cash in < 1 year compared to liabilities that it must pay in < 1 year; shows ability of company to pay debts as they become due. Ideally, this ratio should be over 1. 0. – Normally, the higher the ratio, the more favorable it is for the company. 3

Financial Performance Ratios continued • Debit to equity ratio – Equals total liabilities/owner’s equity – Shows how much the business relies on money borrowed externally versus money from within the business. Ideally, this ratio should be less than 2. 0. – Normally, the lower this ratio, the more favorable it is for the company. 4

Financial Performance Ratios continued • Return on equity ratio – Equals net profit/owner’s equity – Indicates the rate of return the owners/stockholders are receiving on their investments. There is not an ideal ratio; however, it is used to compare with other types of investments to see if there may be another investment that is more desirable. – Normally, the higher the ratio, the more favorable it is for the company. 5

Financial Performance Ratios continued • Net income ratio – Equals total sales/net income – Shows the amount of sales needed for each dollar of net income. While there is not an ideal ratio, managers use this number to compare to past periods to determine how changes in sales affect net income. – Normally, the lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income. 6