Handbook of Finance: Valuation, Financial Modeling, and Quantitative Tools

Chapter 54. Financial Ratio Analysis

PAMELA P. DRAKE, PhD, CFA

J. Gray Ferguson Professor of Finance and Department Head of Finance and Business Law, James Madison University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

Abstract: Financial analysis involves the selection, evaluation, and interpretation of financial data and other pertinent information to assist in evaluating the operating performance and financial condition of a company. The operating performance of a company is a measure of how well a company has used its resources—its assets, both tangible and intangible—to produce a return on its investment. The financial condition of a company is a measure of its ability to satisfy its obligations, such as the payment of interest on its debt in a timely manner. The analyst has many tools available in the analysis of financial information. These tools include financial ratio analysis and quantitative analysis. The analyst must understand how to use these tools, along with economics and accounting information, in the most effective manner.

Keywords: financial ratio, coverage ratio, return ratio, turnover ratio, component percentage, return-on-investment ratios, basic earning power ratio, operating earnings, return on assets, return on equity, equity multiplier, liquidity, liquidity assets, working capital, net working capital, operating cycle, average day's cost of goods sold, number of days of inventory, average credit sales per day, ...