Financial ratios are important for every investor, from many perspectives. They are an important analytical tool to have a clear idea about net enterprise value before you go investing in it. These ratios can help you grasp all the information that surroundsyou in a much easier way.Along with financial statements, investors also need to analyze these ratiosto understand where the company stands in terms of financial stability.
Important Ratios to Consider Before Investing
Financial ratios are important to estimate the enterprise value and the gains from the investment. These ratios are further divided into various categories like liquidity, profitability, price, debt, and efficiency.
Debt to Equity Ratio (D/E):Debt to Equity Ratio calculates the amount of debt that a company owes against the assets that it holds.
Formula: D/E Ratio = Total Debt / Total Assets
Current Ratio: It is calculated using a balance sheet. A ratio of over 1.0 is considered to be optimal as it indicates more short term assets than debts. Meaning, the company can easily increase the liquidity of these assets whenever needed.
Formula: Current Ratio = Current Assets / Current Liabilities
Price to Earnings Ratio (P/E):It calculates how much an investor can expect to pay towards a stock bought.
Formula: P/E Ratio = Stock Price / EPS
Operating Margin Ratio: By measuring total sales flow, Operating Margin ratio calculates the margin of profit that a shareholder would get. It is also known as Profit Margin Ratio.
Formula: Operating Margin = Net Income / Sales
Asset Turnover Ratio: This ratio measuresthe capability of the company in using its assets to manufacture and/or sell its products.
Formula: Asset Turnover Ratio = Sales / Average Total Assets
Dividend Payout Ratio: This ratio is to calculate the percentage of operating margin that shareholders would get. These units that a shareholder gets are called dividends.
Formula: Dividend Payout Ratio = Dividend / Net Income
Defining a Company’s Position Using Ratios
All these ratios give you a clear idea about the company you are investing in. It helps you decide whether the company is worth the investment or not.Informed investment decisions would ensure that you are able to create as well as preserve your wealth. So evaluate your next investment based on these ratios and be a smart investor.