Working with Financial Ratios in Excel

Introduction

Financial ratios are a set of mathematical formulas used to analyze a company’s financial performance. They are calculated using information from a company’s financial statements, such as the balance sheet and income statement.

Knowing how to work with financial ratios in Excel is a valuable business skill. Excel is a powerful tool that can be used to quickly and accurately analyze financial data and make sound financial decisions. Below are some of the benefits of learning how to work with financial ratios in Excel.

Benefits of Learning How to Work with Financial Ratios in Excel

• Easy to calculate and interpret financial information
• Saves time by automating calculations
• Clear visuals of relationships between ratios
• Possibility to quickly compare multiple companies

Key Takeaways

• Easy to calculate and interpret financial information
• Saves time by automating calculations
• Clear visuals of relationships between ratios
• Possibility to quickly compare multiple companies

Gaining an Understanding of Financial Ratios

Financial ratios are analytical tools used to assess a business’s financial health by comparing various components of the financial statements, such as cash flow, debt, investments and operations. Financial ratios can help to identify areas of strength and weakness within an organization, so investors and other stakeholders can make informed decisions. It is important to gain an understanding of financial ratios before attempting to work with them in Excel.

Types of Financial Ratios

Financial ratios can be broken down into five major categories: liquidity ratios, solvency ratios, profitability ratios, efficiency ratios and market ratios.

• Liquidity Ratios – measure the ability of a company to pay off short-term debts using its liquid assets, such as cash, or other current assets
• Solvency Ratios – measure debt levels and the ability of an organization to sustain long-term debt repayments
• Profitability Ratios – measure the performance of an organization’s operations and its ability to generate profits
• Efficiency Ratios – measure the ability of an organization to convert inputs into outputs at a certain rate
• Market Ratios – measure the performance of an organization’s stock price relative to various benchmarks

How to measure the Financial Ratios

The financial ratios are typically calculated using information found on the annual balance sheet and profit and loss statement. The calculations can be tedious and time consuming, but they are necessary to get an accurate understanding of an organization’s financial health. Most financial ratios can be calculated using basic mathematical formulas. For example, the Quick Ratio can be calculated using the formula (Assets – Liabilities) / Liabilities.

Working with financial ratios in Excel can help to make the calculations much easier and more accurate. Excel has many built-in functions that can help you quickly calculate these ratios. In addition, there are various financial templates and add-ins that can be used to make the calculations even faster and easier.

Using Excel to Calculate Financial Ratios

Financial ratios are calculations that analyze the financial health of a company, and determining the specific ratios to look at can be complicated. Excel offers a number of advanced functions that can simplify the process, making it easier for businesses to track their accounting data and interpret the data to assess their overall performance.

Setting up the Columns

The first step when working with financial ratios and Excel is to set up the columns in the spreadsheet. The specific columns will depend on the ratios being calculated and the data available, but the data should be separated into distinct columns so that it is easy to reference the individual cells when creating the formulas. Additionally, it is a good idea to set up the column headings in advance, so that the data is organized clearly and labeled accurately.

Entering the Formulas

Once the columns are organized, the next step is to begin entering the formulas. Each formula should be designed to calculate the specific ratio being analyzed, and should begin with an “=” sign to indicate that it is a formula. The argument for the formula should include the cells that contain the relevant data, and Excel can be used to evaluate the ratios quickly and accurately.

Understanding the Functions Used

When entering formulas, it can be helpful to understand the different functions being used. Excel functions are categorized by their purpose, and some of the commonly used financial functions include SUM, AVERAGE, and COUNT. An understanding of the purpose of each function can make it easier to create more complex formulas, and reviewing the formulas after they are written can help to identify any potential errors.

• SUM: Adds all numbers in a selected range.
• AVERAGE: Calculates the average of a selected range.
• COUNT: Counts the number of cells in a selected range.

Working with Financial Ratios

Financial ratio analysis is an important tool for businesses to assess their financial performance and for evaluating potential risks and transactions. Below we will discuss some key ratios and how to use them effectively.

Assessing Financial Performance

Financial ratios are a key performance indicator that can give businesses insight into the overall financial state of their company. Common financial ratios used to assess performance include:

• Return on Assets (ROA)
• Debt-to-Equity (D/E) Ratio
• Earnings Per Share (EPS)
• Gross Profit Margin

In order to effectively assess financial performance, it is important to compare ratios to industry averages and historical trends to gain a better understanding of the company's performance.

Analysing Potential Risks

Financial ratios can also be used to analyse potential risks associated with any changes in factors like sales, debt, or costs. Common financial ratios used to analyse risk include:

• Interest Coverage Ratio (ICR)
• Quick Ratio (QR)
• Price to Earnings (PE)
• Profit Margin

By tracking current and historical ratios, companies can better understand their exposure to potential risks and develop strategies to mitigate them.

Evaluating Transactions

In addition to assessing company performance and risk, ratios can also be used to evaluate specific transactions. A few ratios used for transaction evaluation are:

• Cash Conversion Cycle (CCC)
• Days Accounts Payable (DAP)
• Return on Equity (ROE)
• Price/Book Ratio (P/B)

By tracking the financial ratios associated with key transactions, businesses can determine whether these transactions are profitable and beneficial to the company. This helps to inform decision making and identify potential areas of improvement.

Common Ratios to Track

Financial analysts use a variety of ratios to evaluate firms. Three of the most widely used ratios are the debt to equity ratio, the return on assets, and the profit margin.

Debt to Equity Ratio

The debt-to-equity ratio, also known as the leverage ratio, is a measure of a firm’s financial leverage. It is computed by dividing total liabilities by shareholders’ equity. The higher ratio indicates a more leveraged firm, and therefore, more risk. A lower ratio may indicate that a firm has more stable operations and is better able to manage its debt.

Return on Assets

Return on assets, also known as ROA, is a measure of a company's profitability. It is calculated by dividing a company’s operating income by its total assets. Companies can use the ROA ratio to compare their performance over time and to compare their performance with their competitors.

Profit Margin

The profit margin is a measure of a company’s profitability. It is computed by dividing a company’s net income by its total sales. A higher margin indicates that the company is more efficient at generating profits from its sales. It is an important metric to measure a company’s ability to generate profits in comparison with its competitors.

Analysis and Interpreting Data

Working with financial ratios in Excel is a great way to gain insights into a company’s business performance. Ratios help to track financial performance and can help to identify weaknesses and strengths. After analyzing the data, it is important to interpret the results and draw conclusions.

Analyzing the trends

Analyzing the trends with financial ratios in Excel requires a thorough examination. Looking at one or two ratios is not enough to get the full picture. Examine the company’s total balance sheet for all periods, analyze the numerators, and assess the changes in the denominators. It may helpful to review yearly reports of the company, as well as quarterly and annual reports from companies in the same industry. This will help to get a better idea of the performance and compare that to the industry.

Judging the performance

Once the trends have been identified, judgment can be made about a company’s performance. Analyzing the ratios against industry averages can demonstrate how a company is doing in comparison to peers. It may also be beneficial to compare the company’s ratios over a period of time to demonstrate performance over a certain period and identify any changes in profitability or liquidity.

Making informed decisions

Analyzing data using financial ratios in Excel can help inform decision making. Ratios can be used to evaluate potential investments, assess potential mergers, and make decisions about capital structure. Analysis of financial data can also help to identify potential risks and weaknesses, and target areas for improvement.

Financial ratios thus can be used to gain insights into a company’s financial health. Analyzing and interpreting the data allows for informed business decisions to be made.

Conclusion

Working with financial data in Excel can be complex, but it doesn't have to be. If you familiarize yourself with the fundamentals of Excel and have a good understanding of financial statements and ratios, you can create powerful financial models with ease. The advantages of using Excel for financial analysis are vast, which include the ability to alter input values for multiple financial components, build projected models of cash flow, profitability and more. It’s cost-effective, and offers great insights. Excel is also highly customizable, so you can tailor it to your specific needs and create user-friendly financial tools that can help with financial reporting, budget analysis, and predictive analysis.