Using ratio analysis in financial forecasting – II

So how to go about organizing financial ratios in proforma sheets?

The best way to go about doing this is to divide the ratios into five broad categories and use these categories to classify the core category ratios within each of these classifications. The categories could be:

• Liquidity Ratios – tells you if the company can pay off its debt and payments falling due within a year
• Activity Ratios – important for manufacturing companies in order to analyze if the inventories, accounts receivables and account payables are handled efficiently; also tells about whether the asset utilization is appropriate.
• Solvency Ratios – Debt repayment capacity of the company; could be critical for some of the companies
• Profitability Ratios – margins earned and return on assets and equity
• Valuation Ratios – how is the market valuing the company measured largely through relative valuation ratios

Once you have linked ratios sheet in place, you could look at the same from time to time to help you guide if you’re going in the right direction or not. In case, you’re unsure about how to check, always try to take a comparative time series analysis into account and check the performance over the years. In some cases, looking at more than one ratio together could tell loads about the company. For example, looking at the accounts receivable turnover, accounts payable turnover and inventory turnover in conjunction with each other could actually provide insights into the big picture of where the possible issues could be as far as the organizational value chain is concerned.