Your money | Inventory Check: Analyze Financial Ratios First

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By Hemanth Gorur

When it comes to stock market investment advice, there is no shortage of online advice, investment portals, and investment apps. However, nothing can replace your own preferred stock analysis and get a first-hand idea of ​​a company’s stock value.

Fundamental analysis using certain financial ratios of company finances helps to do this. There are basically two types of relevant ratios.

Efficiency reports
These are financial ratios that tell us how well the company is using its resources. The asset turnover rate tells us how much and how quickly the company generates sales from its assets.

Asset turnover rate = Net sales / Average total assets
The inventory turnover rate tells us how quickly the company is converting its inventory into finished goods.

Inventory Turnover = Cost of Goods Sold / Average Inventory
The receivables turnover rate tells us how well the company manages its collections from customers and how quickly it generates cash through credit sales.

Receivables turnover rate = Net credit sales / Average receivables
The higher these ratios, the higher the efficiency of the company in the use of its resources.

Profitability ratios
These financial ratios tell us about the overall good functioning of the company in terms of financial performance and its ability to manage its expenses and generate income for its shareholders.

Gross margin tells us about a company’s ability to manage its cost of goods sold or cost of sales.

Gross margin = gross income / net sales
The operating margin tells us about the company’s ability to manage its operating expenses and ensure its operational efficiency.

Operating margin = operating profit / net sales
Return on equity (ROE) and return on assets (ROA) tell us how well the company is able to use its equity and assets respectively to generate a surplus for shareholders.

Return on Equity = net income / equity
Return on assets = net income / total assets

The higher these ratios, the better the financial performance of the company.

Use these ratios to detect good actions
All of the above data is available in the company’s annual reports and audited financial statements, which should be available on the company’s website if it is a listed company, and from the Registrar of Companies (ROC) or the Ministry of Corporate Foreign Affairs (MCA) website. Many companies calculate these ratios themselves and publish them as part of these reports.

The golden rule in using financial ratios to measure the attractiveness of a company’s shares is never to use these ratios in isolation. They should be used in conjunction with other statistics, and this can be done in three ways.

First, compare these financial ratios with the company’s historical values. A trend says a lot more about a company’s performance, in terms of direction and momentum, than just looking at data from a year or quarter.

Second, compare these financial ratios with the industry benchmarks in which the company operates. These industry benchmarks may be available in research reports, research databases, or news articles.

Third, compare these financial ratios with those of the company’s competitors. Sometimes using trends over time or comparing against industry benchmarks may not be enough. Even if the company has positive momentum as indicated by its financial ratios and is well above its industry benchmarks, its competitors can do even better.

When all of the comparisons above show the company in a good light, its stock may be a good bet for long-term investors. So, analyze these ratios diligently and get help from an investment planning professional to make an informed investment decision.

The writer is the founder, Hermoneytalks.com.

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