This process refers to calculating the financial ratios of projects, relating two or more account balances to indicate meaningful ratios. Financial ratio analysis is a method used to evaluate a firm’s financial performance by comparing various ratios derived from its financial statements. Financial ratios can analyse different aspects of the business performance, including, for instance, liquidity, efficiency, profitability, and leverage (or solvency) ratios.
Liquidity ratios that analyse the business’s short-term liquidity include current liquidity (i.e., current assets divided by the current liabilities) and quick liquidity (i.e., current assets without inventory divided by current liabilities).
Efficiency ratios aim at measuring the efficiency of performance and include assets turnover (net revenues divided by net assets), fixed assets turnover (net revenues divided by fixed assets), equity turnover (net revenues divided by equity), loans turnover (net revenues divided by loans), inventory turnover (net of purchasing divided by inventory), receivable turnover (net revenues divided by receivable), payable turnover (purchasing divided by payables), days to cover the inventory (365 days divided by inventory turnover), days of customers’ credits (average collection period) (365 days divided by receivable turnover), days of suppliers’ credit (average payment period) (365 divided by payable turnover).
Profitability ratios measure the project’s profitability, and they include gross margin (gross profit/loss divided by net revenues), net profit margin (net profit divided by the net revenues), profitability index (present values divided by initial investment), return on investment (net profit divided by net assets), return on capital invested, and return on equity (net profit divided by the equity).
Leverage ratios measure the project’s capital structure and long-term financing, especially regarding debt and equity financing. These ratios include debt/equity ratio, debt/asset ratio, interest coverage period (operating profit before interest and tax divided by interest expenses), and debt coverage period (operating profit before interest and tax divided by loans).
The significance of financial ratios evaluates the project’s financial performance and efficiency, and they must be looked at in the context of the industry’s performance to make decisions.
Step-By-Step Process
- Clarify the study’s details on the income statement, balance sheet, and cash flow statements.
- Obtain industry benchmarks, especially regarding financial performance ratios.
- Arrange the financial ratios and share them with your team and expert for discussion.
- Evaluate the project’s financial ratios in line with the industry benchmarks and ensure compatibility.
- Evaluate and test results.
Example
Here are the financial ratios for a pharmaceutical manufacturing facility:
| Purpose | Ratio Name | Ratio Analysis (7th Yr.) |
| Liquidity | Net working capital ($) | 27,795,936 |
| Current ratio | 1903% | |
| Quick ratio | 1700% | |
| Operating cash flow ratio | 22% | |
| Efficiency | Asset turnover ratio | 161% |
| Fixed asset turnover ratio | 904% | |
| Inventory turnover ratio | 410% | |
| Account receivable turnover ratio | 612% | |
| Account payable turnover ratio | 1200% | |
| Average collection period (Days) | 59.60 | |
| Average payment period (Days) | 30 | |
| Profitability | Gross margin ratio | 78% |
| Operating margin ratio | 23% | |
| Net profit margin ratio | 23% | |
| Return on asset ratio | 37% | |
| Return on equity ratio | 57% | |
| Return on capital invested ratio | 38% | |
| Profitability index ratio (Overall-business profitability ratio) | 855% | |
| Financial leverage | Debt ratio | 31% |
| Debt to equity ratio | 48% | |
| Interest coverage ratio | 3445% | |
| Debt coverage ratio | 121% |
Useful Tips
- Align the project’s financial ratios with the industry performance indicators.
- Share the discussion with your team and experts before finalization.
Things To Avoid
- Avoid guessing works and assumptions without evidence.
- Avoid inaccurate ratio calculation.
Final Note
This article is sourced from my new book- Your Guide For Preparing An Industrial Feasibility Study.
For more information about the book: https://growenterprise.co.uk/book-your-guide-for-preparing-an-industrial-feasibility-study/
To register in our newsletter: http://eepurl.com/ggcC29
Or email us at: maldawood@growenterprise.co.uk
The author: Munther Al Dawood- Industrial Enterprise Expert
Grow Enterprise 