Sat. Jun 3rd, 2023

What is a financial ratio used for? ?

Financial ratios are essential in any business takeover, commercial partnership or capital contribution project. Indeed, financial ratios make it possible to assess the financial health of a company. They are therefore decisive for the buyers, partners and potential investors of a company.

Financial ratio: definition

A ratio is a financial analysis tool. It allows to Determine key indicators from the accounting documents of the’business. A financial ratio can be expressed in the form of a percentage or a coefficient Depending on the desired interpretation of the result.

The analysis of the financial ratios of a company gives an overview of its financial statements and its capacity to create value.

The ratios make it possible to provide various financial information on a company (profitability, solvency, liquidity, average stock, cash flow, financial balance, etc.). Thus, they can be used for Improve the legibility of financial data of a business and Pilot your overall assessment.

Concretely, a business financial ratio is calculated by performing a ratio between specific accounting values. It can be based on past or present data depending on the objective sought. The retrospective approach allows, among other things, to carry out a functional and operational assessment of the establishment.

More recent information, on the other hand, is excellent decision-making tools.

Business leaders often favor ratios that use data that reflects the present. In this way they can deploy the best strategy to ensure the development of the company. Future partners or shareholders, on the other hand, prefer past information to assess the feasibility and potential of’a project.

Financial ratio: definition

How to calculate the ratio d’financial autonomy ?

In general, the calculation of a financial ratio is based on figures from the company’s balance sheet. This principle applies in particular to solvency ratios and structural ratios. This is also for the financial autonomy ratio.

This indicator represents the level of net indebtedness of’an institution vis-à-vis its creditors.

This ratio is obtained from the division between equity value of a company and the total balance sheet amount. This method makes it possible to assess the importance of equity in relation to the resources of the company. Note that in a healthy company, this ratio is greater than 0.2 (i.e. 20%).

Below this threshold, the company can be considered not financially self-sufficient. The indicator must however be distinguished from the financial independence ratio. The latter makes it possible to estimate the balance of the financial structure of the company. It is obtained from the division of the amount of equity of the company by the amount of its permanent capital.

In a healthy company, this ratio is greater than 0.5 (i.e. 50%).

How to calculate the financial autonomy ratio?

How to interpret financial ratios ?

Interpreting a financial ratio fundamentally depends on the subject addressed and the purpose of the analysis implemented. For example, the liquidity ratio makes it possible to assess a company’s ability to settle its short-term debts. Indeed, this ratio makes it possible toassess the total amount of cash available to pay any debts of the company.

In other words, the liquidity ratio represents the rotation of current assets in relation to all current liabilitiesculants. The operator is solvent, if the coefficient in question exceeds 1. This type of threshold also represents the basis for interpreting a corporate financial ratio. Like financial indicators, the reference value can be found as a percentage or a coefficient.

Readers of financial data most often focus on revenue and profit. Their first instinct will therefore be to consult the ratios based on turnover and margins. This information must therefore be highlighted and processed carefully.