Ratio Analysis Examples with Comparative Financial Statements

Introduction to Ratio Analysis and Comparative Financial Statements

Ratio analysis is a powerful tool used by businesses and investors to evaluate financial performance and operational efficiency. By comparing ratios from different periods or between companies, stakeholders can identify trends, assess financial health, and make informed decisions. Comparative financial statements provide a side-by-side view of financial data, making it easier to perform this analysis. Below are three diverse examples of ratio analysis using comparative financial statements.

Example 1: Profitability Analysis - Gross Profit Margin

Context

Understanding a company’s profitability is crucial for investors and management. The Gross Profit Margin ratio helps assess how effectively a company is generating profit from its sales, with a focus on production efficiency and pricing strategy.

Example

Company A

• Year 1:
  • Revenue: $500,000
  • Cost of Goods Sold (COGS): $300,000
  • Gross Profit Margin = (Revenue - COGS) / Revenue = ($500,000 - $300,000) / $500,000 = 40%

Company A

• Year 2:
  • Revenue: $600,000
  • Cost of Goods Sold (COGS): $360,000
  • Gross Profit Margin = (Revenue - COGS) / Revenue = ($600,000 - $360,000) / $600,000 = 40%

Notes

Company A maintained a consistent Gross Profit Margin of 40% over the two years, indicating stable production efficiency and pricing strategy. Stakeholders might consider this consistency a positive sign, suggesting that the company is effectively managing its costs relative to its sales.

Example 2: Liquidity Analysis - Current Ratio

Context

The Current Ratio is a key indicator of a company’s short-term financial health and its ability to cover its short-term liabilities with its short-term assets. Investors and creditors use this ratio to evaluate liquidity risk.

Example

Company B

• Year 1:
  • Current Assets: $200,000
  • Current Liabilities: $100,000
  • Current Ratio = Current Assets / Current Liabilities = $200,000 / $100,000 = 2.0

Company B

• Year 2:
  • Current Assets: $250,000
  • Current Liabilities: $150,000
  • Current Ratio = Current Assets / Current Liabilities = $250,000 / $150,000 = 1.67

Notes

Company B’s Current Ratio decreased from 2.0 to 1.67, which indicates a decline in liquidity over the period. While a ratio above 1 is generally considered healthy, the downward trend may raise concerns for investors about the company’s ability to meet its short-term obligations in the future.

Example 3: Efficiency Analysis - Inventory Turnover Ratio

Context

The Inventory Turnover Ratio measures how efficiently a company manages its inventory and how quickly it sells its products. A higher ratio indicates efficient inventory management, while a lower ratio may suggest overstocking or slowing sales.

Example

Company C

• Year 1:
  • Cost of Goods Sold: $400,000
  • Average Inventory: $100,000
  • Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory = $400,000 / $100,000 = 4.0

Company C

• Year 2:
  • Cost of Goods Sold: $500,000
  • Average Inventory: $125,000
  • Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory = $500,000 / $125,000 = 4.0

Notes

Company C maintained an Inventory Turnover Ratio of 4.0 across both years, indicating consistent efficiency in managing its inventory. This level suggests that the company sold and replenished its inventory four times each year, which may be viewed favorably by potential investors looking for effective inventory management practices.