Scribd
Upload
140 views3 pages

Understanding Financial Ratios Explained

Financial ratios are mathematical comparisons of financial statement accounts that help analyze a business's financial performance and identify strengths and weaknesses. Ratios are commonly used to compare companies across industries regardless of size. There are seven main categories of financial ratios including liquidity, solvency, efficiency, profitability, market prospect, leverage, and coverage ratios. Earnings per share (EPS) is a market prospect ratio that measures the amount of net income earned per outstanding share of stock, showing how profitable a company is on a per-share basis. EPS is calculated by subtracting preferred dividends from net income and dividing by the weighted average common shares outstanding.

Uploaded by

Ellaine Pearl Almilla
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
140 views3 pages

Understanding Financial Ratios Explained

Financial ratios are mathematical comparisons of financial statement accounts that help analyze a business's financial performance and identify strengths and weaknesses. Ratios are commonly used to compare companies across industries regardless of size. There are seven main categories of financial ratios including liquidity, solvency, efficiency, profitability, market prospect, leverage, and coverage ratios. Earnings per share (EPS) is a market prospect ratio that measures the amount of net income earned per outstanding share of stock, showing how profitable a company is on a per-share basis. EPS is calculated by subtracting preferred dividends from net income and dividing by the weighted average common shares outstanding.

Uploaded by

Ellaine Pearl Almilla
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Financial ratios are mathematical comparisons of financial statement accounts or categories.

These
relationships between the financial statement accounts help investors, creditors, and internal company
management understand how well a business is performing and of areas needing improvement.

Financial ratios are the most common and widespread tools used to analyze a business’ financial
standing. Ratios are easy to understand and simple to compute. They can also be used to compare
different companies in different industries. Since a ratio is simply a mathematically comparison based on
proportions, big and small companies can be use ratios to compare their financial information. In a
sense, financial ratios don’t take into consideration the size of a company or the industry. Ratios are just
a raw computation of financial position and performance.

Ratios allow us to compare companies across industries, big and small, to identify their strengths and
weaknesses. Financial ratios are often divided up into seven main categories: liquidity, solvency,
efficiency, profitability, market prospect, investment leverage, and coverage.

 Liquidity Ratios

 Solvency Ratios

 Efficiency Ratios

 Profitability Ratios

 Market Prospect Ratios

 Financial Leverage Ratios

 Coverage Ratios

 Receivables Turnover Ratio

 Asset Turnover Ratio

 Cash Conversion Cycle

 Cash Ratio

 Compound Annual Growth Rate

 Contribution Margin

 Current Ratio

 Days Sales in Inventory

 Days Sales Outstanding

 Debt Ratio

 Debt Service Coverage Ratio

 Debt to Equity Ratio

 Dividend Payout
 Dividend Yield

Earning per share (EPS), also called net income per share, is a market prospect ratio that measures the
amount of net income earned per share of stock outstanding. In other words, this is the amount of
money each share of stock would receive if all of the profits were distributed to the outstanding shares
at the end of the year.

Earnings per share is also a calculation that shows how profitable a company is on a shareholder basis.
So a larger company’s profits per share can be compared to smaller company’s profits per share.
Obviously, this calculation is heavily influenced on how many shares are outstanding. Thus, a larger
company will have to split its earning amongst many more shares of stock compared to a smaller
company.

Formula

Earnings per share or basic earnings per share is calculated by subtracting preferred dividends from net
income and dividing by the weighted average common shares outstanding. The earnings per share
formula looks like this.

Earnings Per Share

You’ll notice that the preferred dividends are removed from net income in the earnings per share
calculation. This is because EPS only measures the income available to common stockholders. Preferred
dividends are set-aside for the preferred shareholders and can’t belong to the common shareholders.

Most of the time earning per share is calculated for year-end financial statements. Since companies
often issue new stock and buy back treasury stock throughout the year, the weighted average common
shares are used in the calculation. The weighted average common shares outstanding is can be
simplified by adding the beginning and ending outstanding shares and dividing by two.

Analysis

Earning per share is the same as any profitability or market prospect ratio. Higher earnings per share is
always better than a lower ratio because this means the company is more profitable and the company
has more profits to distribute to its shareholders.
Although many investors don’t pay much attention to the EPS, a higher earnings per share ratio often
makes the stock price of a company rise. Since so many things can manipulate this ratio, investors tend
to look at it but don’t let it influence their decisions drastically.

Example

Quality Co. has net income during the year of $50,000. Since it is a small company, there are no
preferred shares outstanding. Quality Co. had 5,000 weighted average shares outstanding during the
year. Quality’s EPS is calculated like this.

Earnings Per Share Formula

As you can see, Quality’s EPS for the year is $10. This means that if Quality distributed every dollar of
income to its shareholders, each share would receive 10 dollars.

You might also like