The concept of financial statements
Financial statements are brief reports that clarify the nature of companies' use of funds, whether they are their own, or responsible for managing them such as the money of shareholders and lenders. The financial statements also help determine the value of the company's current financial position; Through the study of its financial statements, the financial statements are defined as financial reports submitted by companies to investors and shareholders, and contribute to clarifying the details of their financial conditions, and include documents that refer to loss and profit accounts, and others.
Other definitions of financial statements are official records that contain financial information related to a business, and are presented in a standardized and organized manner that helps to understand them easily.
Analyzing financial statements using ratios
Analysis using ratios is a financial analysis method that seeks to convert the quantities of numbers into ratios in order to apply comparisons between them; By relying on a comparison between the current and previous ratios of companies operating in a similar or different industry, this type of analysis contributes to identifying the company’s weaknesses and strengths, and the analysis of financial statements using ratios is defined as a means that aims to study the various relationships between The numbers and amounts in the companies' financial statements; In order to determine its success in the labor market.
Another definition of financial statement analysis using ratios is a tool that is used to build a comparison between the various relationships in the various financial sectors, and financial statement analysis information is obtained through financial statements such as the income statement and the balance sheet.
Sections of financial ratios
The financial ratios used in the analysis of financial statements are divided into the following:
Liquidity ratios: These are the ratios that measure the short-term financial ability of a company; That is, you are interested in knowing the extent to which the company can pay its financial obligations within a short period, and this financial capacity contributes to clarifying the nature of the current financial liabilities depending on the company’s tradable assets, which can be converted into cash in a period of time equal to the entitlements of current liabilities, and also The presence of sufficient financial liquidity for companies, the possibility of a risk in financing, which leads to a decline in their credit rating, and the most important ratios of liquidity are:
Current Ratio: It is the ratio that is calculated by dividing current assets by current liabilities.
Quick ratio: It is the ratio that is calculated by subtracting the value of inventory from the value of current assets, and then dividing the result by the value of current liabilities. The importance of this ratio appears through its role in measuring the ability of projects to pay short-term financial obligations, without the need to sell the value of inventory.
Financial leverage ratios: These are the ratios that are concerned with the company's degree of financing; By relying on indebtedness to others (leverage); That is, it is used to measure the company's ability to pay all its debts on the due date, regardless of the nature of these debts, whether they are short or long-term. The most important financial leverage ratios are:
Debt to Net Assets Ratio: The ratio that measures a company's ability to rely on other people's money; In order to use it to finance its needs, this ratio is calculated by dividing the net value of all debts by the net asset value. New partners.
Capital Structure Ratio: It is the ratio that is calculated by dividing the long-term net debt by the long-term financing sources, and this ratio is used to judge the nature of the financial risk.
Coverage ratio: It is the ratio that measures the company's ability to pay interest on loans; By relying on the value of its earnings, it is calculated by dividing the value of income before taxes and interest by the value of the interest paid annually.
Profitability ratios: are the ratios that measure the company's ability to make profits; By relying on its assets, sales, and ownership rights, the most important profitability ratios are:
Gross Profit Ratio: It is the ratio that is used to indicate the management's efficiency in supporting sales and controlling costs, and it is calculated by dividing the total profit (sales value - the cost of goods for sale) by the total sales.
Operating profit margin ratio: It is the ratio that is used to measure the operating efficiency of the company, and it is calculated by dividing the value of operating profit by the total sales.
Gross Income Ratio: It is the ratio used to measure the ability of sales to produce total income, and is calculated by dividing total income by total sales.
Activity ratios: They are the ratios that measure the efficiency of managing the company's resources; By comparing its sales with its investments within a group of assets; That is, it contributes to determining the company's efficiency by distributing financial resources to various assets, and also studies the efficiency of using assets to produce the largest amount of services and goods. The most important activity ratios are:
Accounts receivable turnover: It is the number of times during the year that accounts receivable are collected, and is calculated by dividing total sales by the value of accounts receivable.
Inventory turnover: It is the number of times a company purchases a quantity of goods with the aim of selling it. Inventory turnover contributes to measuring the percentage of administrative efficiency in the company to follow up on its assets, and to maintain assets within their ideal limits appropriate to the size of its operations. Inventory turnover ratio also serves to determine the appropriateness of investment within the inventory. Commodity.
Fixed asset turnover: It is a measure of the management’s efficiency ratio based on its net assets in order to support its sales. A high percentage indicates the excellent use of assets, but if it is low, this indicates that the company cannot produce an appropriate sales volume compared to the nature of the investment used.
Steps to analyze financial statements using ratios
The application of financial statement analysis using ratios depends on a set of steps, namely:
calculating common volume ratios; By relying on the company's balance sheet.
calculating common volume ratios; Through the financial statements of the income statement.
Use balance sheet data to calculate both current financial ratios and quick financial ratios.
The application of calculating both the ratio of debt and total sales to the current capital of the company.