Analysis of financial ratios

Analysis of financial ratios: A comparative study of

two companies

Financial ratio analysis is a powerful tool that allows meaningful comparisons between

companies operating within the same industry. By objectively examining key metrics calculated

from financial statements, analysts gain valuable insights into relative operational efficiency,

viability, growth potential and risks.

This paper analyses and compares important financial ratios of Companies A and B over a

three-year period from 2019 to 2021. Company A is a leading player in the consumer durables

sector while Company B is another major player within the same industry.

to costs, assets and equity employed. Strong and consistent profitability is fundamental to

sustainability and value creation.

Company A's gross margins were 35%, 38% and 39% over the three years while Company B

reported 38%, 40% and 41% respectively. Both companies saw margins improve, though

Company B had an edge each year. This reflects relatively better control over COGS, and

hence operating efficiency.

Here Company A reported net margins of 12%, 14%, 15% versus Company B's 13%, 15%, 16%

over the period. Company B thus enjoyed a slight but consistent net profitability advantage,

bolstering its overall earnings power relative to Company A.

Return on Assets (ROA)

ROA measures how productively a company uses its total assets to generate profits. It indicates

the efficiency with which assets are deployed.

Company A posted ROAs of 9%, 10%, 11% whereas Company B achieved 10%, 11% 12%.

This confirms Company B as having an advantage in converting its asset base into net income

ROE reveals how effectively equity capital invested has been used to generate profits. Higher

B was therefore relatively more successful in deploying shareholder funds to yield profits,

underscoring its marginally superior overall stewardship of capital.

investments compared to Company A over the analysis period. This suggests better operational

efficiencies and management yielding stronger bottom-line performances.

Liquidity ratios measure a company's ability to meet its short-term financial obligations from its

most liquid assets like cash and near-cash items. Adequate coverage provides a buffer to fulfill

This metric compares current assets to current liabilities. A ratio above 1 suggests obligations

not be swiftly converted to cash in times of short-notice obligations.

Here Company A reported quick ratios of 0.8, 0.9 and 1 whereas Company B achieved 0.9, 1

and 1.1, demonstrating slightly better short-term debt servicing ability excluding inventories.

Overall, while both companies displayed adequate liquidity, Company B appears to have

maintained a somewhat healthier current asset buffer relative to current liabilities based on the

minor advantages revealed. Its superior liquidity profile highlights greater financial flexibility.

debt increases risks.

This metric measures the proportion of debt financing versus equity capitalisation, signifying

B's 1.1, 1 and 0.9 ratios. Both decreased leverage prudently over time, with Company B

Interest coverage denotes the number of times earnings can cover annual interest outgo,

indicating debt-servicing ability.

At 5.6, 6.2 and 6.8 times, Company A's coverage comfortably exceeded the minimum

benchmark of 3 times. Company B's ratios of 6, 6.5 and 7 were marginally healthier. This

implies its debt-related vulnerabilities were somewhat better contained.

Overall, Company B leveraged its balance sheet mildly more conservatively than Company A

based on its debt ratios. Its interest coverage also provided an incrementally stronger buffer

more secure financial structure.

Activity/efficiency ratios assess how well a company utilizes its resources to generate sales

This measures the number of times inventory is sold or used in a period. Higher turnover is

optimal to minimize obsolescence risks.

Company A's inventory turnover was 5, 5.5 and 6 times versus Company B's 6, 6.5 and 7 times

each year, underlining its strength in swiftly rotating stocks through sales. Efficient stock

Here Company A's asset turnover was 1.5, 1.6 and 1.7 times each year while Company B

capacity to leverage assets for revenue generation.

Overall, activity/efficiency ratios point to Company B exhibiting somewhat swifter inventory and

generating sales compared to Company A over the three-year period. This bolsters its cash

generation prowess relatively.

Investment ratios help assess return on capital employed and future growth prospects. Strong,

Return on Capital Employed (ROCE)

It evaluates overall operating efficiency.

Company A's ROCE stood at 15%, 17% and 18% versus Company B's 16%, 18%, 19%

respective ratios each year. Company B enjoyed a small yet continual edge in generating

incomes relative to total capital funds employed in its operations.

Price to Earnings Ratio (P/E Ratio)

a share. Lower P/E denotes undervaluation or growth attractiveness.

Company A's P/E ratios were 18, 16, 15 times over three years compared to Company B's 17,

15, 14 times respectively. The ratios decreased progressively for both as profits rose faster than

than Company A. Its share price also appeared comparatively undervalued according to

In summary, the detailed comparative analysis of key financial ratios over a three-year period

indicates that while both Company A and Company B exhibited sound financial performances

within the consumer durables industry, Company B emerged as the stronger organization based

on marginally better trends.

Specifically, Company B demonstrated relative advantages in areas like profitability, liquidity,

leverage, activity efficiency and returns on capital employed. Most ratios analyzed revealed

placed currently and likely over the long run compared to Company A within this industry based

on holistic multi-year ratio trends. Overall, Company B's financials portray some relative

strengths that provide reassuring signs of sustainability and potential value creation for

stakeholders over time.

Financial ratio analysis is a powerful tool that allows meaningful comparisons between

companies operating within the same industry. By objectively examining key metrics calculated

from financial statements, analysts gain valuable insights into relative operational efficiency,

This paper analyses and compares important financial ratios of Companies A and B over a

three-year period from 2019 to 2021. Company A is a leading player in the consumer durables

sector while Company B is another major player within the same industry.

The objective is to gain a comprehensive understanding of relative financial performances,

identify relative strengths and weaknesses, and make an assessment of which company is

better placed financially based on trends in key ratios. This comparative ratio analysis offers

Profitability Ratios

Profitability ratios measure a company's ability to generate earnings from its operations relative

to costs, assets and equity employed. Strong and consistent profitability is fundamental to

Company A's gross margins were 35%, 38% and 39% over the three years while Company B

Company B had an edge each year. This reflects relatively better control over COGS, and

and 23%. Again, Company B demonstrated better margins, ability to contain operating

expenses and extract higher profits from each rupee of sales revenue generated.

Net profit margin indicates bottom-line profitability after all expenses including tax.

Here Company A reported net margins of 12%, 14%, 15% versus Company B's 13%, 15%, 16%

over the period. Company B thus enjoyed a slight but consistent net profitability advantage,

bolstering its overall earnings power relative to Company A.

ROA measures how productively a company uses its total assets to generate profits. It indicates

the efficiency with which assets are deployed.

Company A posted ROAs of 9%, 10%, 11% whereas Company B achieved 10%, 11% 12%.

This confirms Company B as having an advantage in converting its asset base into net income

more efficiently than Company A.

Return on Equity (ROE)

ROE reveals how effectively equity capital invested has been used to generate profits. Higher

Company A's ROEs stood at 12%, 14%, 15% versus Company B's 13%, 15%, 16%. Company

underscoring its marginally superior overall stewardship of capital.

investments compared to Company A over the analysis period. This suggests better operational

Current Ratio

satisfactory coverage, though Company B boasted healthier liquidity.

not be swiftly converted to cash in times of short-notice obligations.

Here Company A reported quick ratios of 0.8, 0.9 and 1 whereas Company B achieved 0.9, 1

Overall, while both companies displayed adequate liquidity, Company B appears to have

maintained a somewhat healthier current asset buffer relative to current liabilities based on the

minor advantages revealed. Its superior liquidity profile highlights greater financial flexibility.

Capital Structure Ratios

Capital structure ratios reveal how a company has financed its assets through various sources

of capital, balancing debt and equity. Prudent leverage enhances returns whereas excessive

This metric measures the proportion of debt financing versus equity capitalisation, signifying

B's 1.1, 1 and 0.9 ratios. Both decreased leverage prudently over time, with Company B

indicating debt-servicing ability.

implies its debt-related vulnerabilities were somewhat better contained.

against adverse impacts of debt financing costs. This suggests Company B adopted a slightly

more secure financial structure.

Activity/Efficiency Ratios

Activity/efficiency ratios assess how well a company utilizes its resources to generate sales

Inventory Turnover Ratio

This measures the number of times inventory is sold or used in a period. Higher turnover is

Company A's inventory turnover was 5, 5.5 and 6 times versus Company B's 6, 6.5 and 7 times

each year, underlining its strength in swiftly rotating stocks through sales. Efficient stock

Receivables Turnover Ratio

This indicates the number of times average receivables from credit sales are collected during a

receiving cash from customers after extending credit.

Here Company A's asset turnover was 1.5, 1.6 and 1.7 times each year while Company B

capacity to leverage assets for revenue generation.

Overall, activity/efficiency ratios point to Company B exhibiting somewhat swifter inventory and

improving ratios attract shareholder capital for expansion.

ROCE denotes pre-tax profitability of both debt and equity capital net of reserves and surpluses.

It evaluates overall operating efficiency.

The objective is to gain a comprehensive understanding of relative financial performances,

identify relative strengths and weaknesses, and make an assessment of which company is

better placed financially based on trends in key ratios. This comparative ratio analysis offers

Profitability ratios measure a company's ability to generate earnings from its operations relative

to costs, assets and equity employed. Strong and consistent profitability is fundamental to

sustainability and value creation.

reported 38%, 40% and 41% respectively. Both companies saw margins improve, though

Company B had an edge each year. This reflects relatively better control over COGS, and

and 23%. Again, Company B demonstrated better margins, ability to contain operating

over the period. Company B thus enjoyed a slight but consistent net profitability advantage,

ROA measures how productively a company uses its total assets to generate profits. It indicates

the efficiency with which assets are deployed.

Company A posted ROAs of 9%, 10%, 11% whereas Company B achieved 10%, 11% 12%.

This confirms Company B as having an advantage in converting its asset base into net income

more efficiently than Company A.

Return on Equity (ROE)

ROE reveals how effectively equity capital invested has been used to generate profits. Higher

Company A's ROEs stood at 12%, 14%, 15% versus Company B's 13%, 15%, 16%. Company

investments compared to Company A over the analysis period. This suggests better operational

most liquid assets like cash and near-cash items. Adequate coverage provides a buffer to fulfill

This metric compares current assets to current liabilities. A ratio above 1 suggests obligations

not be swiftly converted to cash in times of short-notice obligations.

and 1.1, demonstrating slightly better short-term debt servicing ability excluding inventories.

Overall, while both companies displayed adequate liquidity, Company B appears to have

Capital structure ratios reveal how a company has financed its assets through various sources

of capital, balancing debt and equity. Prudent leverage enhances returns whereas excessive

Debt to Equity Ratio

This metric measures the proportion of debt financing versus equity capitalisation, signifying

Company A's debt-equity ratios were 1.2, 1.1 and 1 for the three years compared to Company

B's 1.1, 1 and 0.9 ratios. Both decreased leverage prudently over time, with Company B

Interest coverage denotes the number of times earnings can cover annual interest outgo,

At 5.6, 6.2 and 6.8 times, Company A's coverage comfortably exceeded the minimum

implies its debt-related vulnerabilities were somewhat better contained.

based on its debt ratios. Its interest coverage also provided an incrementally stronger buffer

more secure financial structure.

Activity/efficiency ratios assess how well a company utilizes its resources to generate sales

optimal to minimize obsolescence risks.

Company A's inventory turnover was 5, 5.5 and 6 times versus Company B's 6, 6.5 and 7 times

This indicates the number of times average receivables from credit sales are collected during a

17 and 18 times annually. Company B thus displayed marginally better effectiveness in promptly

receiving cash from customers after extending credit.

This ratio signifies the efficiency with which total assets are employed to generate annual net

Here Company A's asset turnover was 1.5, 1.6 and 1.7 times each year while Company B

capacity to leverage assets for revenue generation.

generating sales compared to Company A over the three-year period. This bolsters its cash

Investment ratios help assess return on capital employed and future growth prospects. Strong,

It evaluates overall operating efficiency.

Company A's ROCE stood at 15%, 17% and 18% versus Company B's 16%, 18%, 19%

incomes relative to total capital funds employed in its operations.

a share. Lower P/E denotes undervaluation or growth attractiveness.

Company A's P/E ratios were 18, 16, 15 times over three years compared to Company B's 17,

15, 14 times respectively. The ratios decreased progressively for both as profits rose faster than

price. However, Company B again held a marginal discount indicative of share undervaluation

than Company A. Its share price also appeared comparatively undervalued according to

investment ratios, suggesting a more compelling growth profile for investors.

on marginally better trends.

leverage, activity efficiency and returns on capital employed. Most ratios analyzed revealed

cash flows and balance sheet conservatism.

Investment ratios further suggested Company B's stock offered better total return potential for

shareholders driven by undervaluation and capacity to deliver high future earnings growth

In conclusion, the ratio study indicates that from a financial standpoint, Company B is better

placed currently and likely over the long run compared to Company A within this industry based

three-year period from 2019 to 2021. Company A is a leading player in the consumer durables

identify relative strengths and weaknesses, and make an assessment of which company is

better placed financially based on trends in key ratios. This comparative ratio analysis offers

Profitability ratios measure a company's ability to generate earnings from its operations relative

to costs, assets and equity employed. Strong and consistent profitability is fundamental to

Company A's gross margins were 35%, 38% and 39% over the three years while Company B

reported 38%, 40% and 41% respectively. Both companies saw margins improve, though

hence operating efficiency.

Company A's operating margins were 18%, 20% and 21% compared to Company B's 20%, 22%

expenses and extract higher profits from each rupee of sales revenue generated.

the efficiency with which assets are deployed.

This confirms Company B as having an advantage in converting its asset base into net income

ROE reveals how effectively equity capital invested has been used to generate profits. Higher

Company A's ROEs stood at 12%, 14%, 15% versus Company B's 13%, 15%, 16%. Company

B was therefore relatively more successful in deploying shareholder funds to yield profits,

investments compared to Company A over the analysis period. This suggests better operational

Here Company A reported quick ratios of 0.8, 0.9 and 1 whereas Company B achieved 0.9, 1

maintained a somewhat healthier current asset buffer relative to current liabilities based on the

Capital structure ratios reveal how a company has financed its assets through various sources

This metric measures the proportion of debt financing versus equity capitalisation, signifying

Company A's debt-equity ratios were 1.2, 1.1 and 1 for the three years compared to Company

B's 1.1, 1 and 0.9 ratios. Both decreased leverage prudently over time, with Company B

Interest coverage denotes the number of times earnings can cover annual interest outgo,

indicating debt-servicing ability.

against adverse impacts of debt financing costs. This suggests Company B adopted a slightly

Activity/efficiency ratios assess how well a company utilizes its resources to generate sales

This measures the number of times inventory is sold or used in a period. Higher turnover is

each year, underlining its strength in swiftly rotating stocks through sales. Efficient stock

This indicates the number of times average receivables from credit sales are collected during a

receiving cash from customers after extending credit.

This ratio signifies the efficiency with which total assets are employed to generate annual net

Here Company A's asset turnover was 1.5, 1.6 and 1.7 times each year while Company B

Overall, activity/efficiency ratios point to Company B exhibiting somewhat swifter inventory and

improving ratios attract shareholder capital for expansion.

Return on Capital Employed (ROCE)

It evaluates overall operating efficiency.

Company A's ROCE stood at 15%, 17% and 18% versus Company B's 16%, 18%, 19%

Price to Earnings Ratio (P/E Ratio)

price. However, Company B again held a marginal discount indicative of share undervaluation

Overall, Company B demonstrated stronger and more consistent returns on capital investments

investment ratios, suggesting a more compelling growth profile for investors.