Liquidity Ratio Part Two
When looking at a company’s financial details while considering investment, a significant item to review is various types of liquidity ratio. This represents a company’s capability in satisfying short-term debt obligations. You absolutely need to know this kind of stuff if you are going to be investing on your own in 2018.
We will take a look at some of the key points of an organization’s liquidity ratio, starting with the debt service coverage ratio, or DSCR. The interest coverage ratio measures the ability of a company to pay the interest on their outstanding debts. However, there are other commitments besides interest payments that a company is liable to pay. These include the principal of the debt, lease rentals and principle amount of other interest-free loans. Moreover, since debts are paid out of cash flows, creditors are interested in the amount of cash flow the company earns annually instead of operating profits. The debt service coverage ratio, or the DSCR is a liquidity ratio that measures the ability of a company to pay the interest and principle of all long-term debt. It is calculated as:
Debt Service Coverage Ratio = (PBT+ Depreciation+ Other non-cash charges+ … Read the rest
Limitations Of Financial Ratios
While you are observing financial ratios in your exploration, or fundamental analysis of a security to reach a decision to buy or reject, keep in mind the potential for these limitations of financial ratios.
Limitations of Financial Ratios
Financial ratios provide valuable insight into a company’s performance, efficiency and future growth prospects. However, limitations of financial ratios can exist when analyzing a stock, you must keep certain things in mind before interpreting these ratios. These ratios cannot be interpreted in isolation. Alternatively they should be compared with industry averages and ratios of competitors in the industry. For example, a net profit margin of 10% may sound low, but it may be considered normal if the company is operating in the infrastructure industry. Similarly, ratios vary across industries. While a net profit margin of 12% may be outstanding for one type of industry, it may be considered as mediocre to poor for another.
Trend analysis of ratios can provide better insight into a company’s performance. However, it is important to be sure that the assumptions applied in calculating the ratios are constant throughout.
Some ratios include items from the income statement and balance sheet, such as return
… Read the rest