Learn more about Financial analysis
Financial analysts often assess the firm's:
- performance, for the management to improve operations,
- solvency, so a bank or a supplier can safely grant credit,
- potential value to decide an investment or divestment. Then it is called fundamental analysis and is linked to business valuation and stock valuation
- Across historical time periods for the same firm (the last 5 years for example)
- In forecasts of the firm's anticipated future performance
- And among similar firms.
- Net profit / equity = return on equity
- Gross profit / balance sheet total = return on assets
- Stock price / earnings per share = P/E-ratio
Comparing financial ratios merely one way of conducting financial analysis. Financial ratios face several theoretical challenges:
- They say little about the firm's prospects in an absolute sense. Their insights about relative performance require a reference point from other time periods or similar firms.
- One ratio holds little meaning. As indicators, ratios can be logically interpreted in at least two ways. One can partially overcome this problem by combining several related ratios to paint a more comprehensive picture of the firm's performance.
- Seasonal factors may prevent year-end values from being representative. A ratio's values may be distorted as account balances change from the beginning to the end of an accounting period. Use average values for such accounts whenever possible.
- Financial ratios are no more objective than the accounting methods employed. Changes in accounting policies or choices can yield drastically different ratio values.
- They fail to account for exogenous factors like investor behavior that are not based upon economic fundamentals of the firm or the general economy (fundamental analysis) <ref> http://www.netmba.com/finance/financial/ratios/ </ref>.
 See also
- Business valuation
- Fair value
- Fundamental analysis
- Return on capital
- Stock valuation
- Financial planning
 External links
- ProfitCents - This site provides financial analysis tools to convert complex financial data into plain language and understandable analysis.