Financial Ratios for Chester: Analysis and Evaluation

Discussion Week 4
Introduction
Financial Ratios is one of the most important tools for financial analysis as they present data in
relative form for relative comparison between companies. There are various types of ratios to
evaluate the financial health of the organisation and they are as below:
A. Liquidity Ratios:
They give an idea about the liquidity position of the firm, meaning how well the company will be
able to pay off its short term debts with the current assets it holds. The two major ratios
considered here are
 Current ratio is the ratio of the current assets and current liabilities of the firm. They
indicate how many times the current assets are capable to pay of the company’s short-
term liabilities.
 Quick Ratio or the Acid Test Ratio on the other hand is the ratio of Current assets minus
inventory and prepaid expense to current liabilities, i.e. a ratio of most liquid assets to the
liabilities of the firm.
B. Activity Ratios:
Activity or the Turnover ratios is an indication of the efficiency of the firm in maintaining its
various cycles. It shows the frequency when the assets are converted into cash or when the
payments are made and received. It also shows how well the company is utilising its fixed asset.
 Inventory Turnover Ratio - This ratio tells us about how well the company is managing
its inventory position or to say how many times the inventory of the company is replaced
and sold over a period of time.
 Receivables and payables turnover are also important to realise how well the company is
able to realise payments for products sold on credit and also how effectively the company
is paying off its suppliers in a year.
C. Leverage Ratios:
Leverage or the debt management ratios, measure the financing efficiency of the firm. It
highlights the use of debt and equity in the overall financing of the company, debt and equity

both had their own pros and cons and striking the right balance between the two is of key
importance to the company. The ratio studied here are: Debt Ratio, Debt – Equity Ratio and
Long Term Debt to Equity Ratio.
Debt ratio indicates the usage of debt in the financing of the firm; it is the ratio of Total debt as
against the Total assets with the company. The assets in the company should be well managed
and they should be able to wave off the liabilities of the firm.
D. Profitability Ratios:
Profitability or the performance ratios indicates the ability of the firm to generate profits over its
sales, assets and equity of the firm. Higher the ratios better is the company performing. The
ratios studied here are Gross Profit Margin, Operating Profit Margin, Net profit margin or the
Basic earning Power, Return on Assets (ROA) and Return on Equity (ROE).
E. Valuation Ratios:
Valuation ratios represent the market valuation of the company in terms of fundamentals of the
company. It is indicative of the potential of the company for future returns. The various ratios I
have analysed here are Price – Earnings (P/E) Ratio and Earnings per share.