• Financial ratios: choice and calculation

Financial ratios are used to evaluate profitability, financial structure, cash flow and
the activity of a company. These tools are particularly used in the evaluation phase conducted beforehand.
ofbuy back a companyor to compare its performance with other companies in the same sector.
Given the multitude of existing financial ratios, it is necessary to select the most relevant ones in
function of your company and your activity. Once calculated, the financial ratios allow obtaining
simple information to analyze that will allow for easy detection of strengths and weaknesses of
the company.

The different types of financial ratios

There are several types of financial analysis ratios:

• those that allow studying the profitability of the company,
• those who analyze the financial structure of the company,
• those who are more focused on cash flow,
• and finally ratios related to activity.

Financial ratios related to profitability analysis

These profitability-oriented financial analysis ratios are more focused on elements found in
the income statement. We thus find the following ratios:
• the ratios used to measure the profitability of the activity include:
the calculation in relation to the net result:

Net result / Revenue (CA)

and the calculation in relationto theEBE:

Gross operating surplus (GOS) / Revenue

Advice: These ratios are very useful for comparing with competitors and ensure that the company
master both its costs and its selling prices.
• the ratios used to measure profitability in relation to the resources deployed:
The main ratio used is as follows:

Net income / Equity

• the other ratios related to the income statement:
There is a ratio related to the income statement that is very important, it is the production margin rate or
youcommercial margin rate, sdepending on the company's activity. The calculation of the margin rate is as follows:
(Revenue excluding tax - purchases and/or consumed services excluding tax) / Revenue excluding tax

This rate measures the percentage of revenue remaining after consumption of purchases and/or services.
directly related to achieving this turnover.

The financial ratios related to the analysis of the balance sheet

These ratios analyze the financial structure of the company. In particular, we find:
• the financial equilibrium ratios with the calculation of the net working capital and the need for funds
bearing
The net working capital (NWC) is calculated as follows:
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 Permanent capital (upper liabilities) - fixed assets

If the FRNG is positive, it is a positive indicator of solvency for the company, and conversely if the
FRNG is negative.
The working capital requirement (WCR) is calculated as follows:

Current assets - short-term liabilities

The working capital requirement highlights the gap between the income and the expenses necessary for the activity of
the company. When the working capital requirement is negative, the company must find solutions to finance it. For more
information:the financing of companies.
• the liquidity ratios, which measure the company's ability to repay its short-term debts.
It essentially concerns the following ratio:

Current Assets / Current Liabilities

• the debt ratios, which measure the financial independence of the company in relation to creditors.
Two ratios are often used for this indicator.
Total debt / equity

you

Medium and long-term debt / equity

Financial ratios related to cash flow analysis

We particularly find in the cash-oriented financial analysis ratios:

• the average payment period for suppliers in days
(Total suppliers' debts including taxes / Total purchases including taxes) * 360

An extension of this deadline is a possible sign of cash flow difficulties.

• the average payment period for customers in days
(Customer receivables including taxes / Total sales including taxes) * 360

An extension of this deadline can be explained by a deterioration in the solvency of the company's clients.
or by the existence of disputes.
• net cash flow
Cash on the asset side - cash on the liability side

or

Working capital–BFR

The financial ratios related to activity analysis

For this type of ratios, we diverge slightly from financial analysis but these indicators deserve attention.
particular.

Depending on your industry, there are some ratios that are very important for managing your
business. We will take the example of e-commerce and the example of paid information sites
of advertising advertisers.

In the first case, the following ratios are important: the average basket or the conversion rate of visitors.

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 In the second case, we rather use the following ratios: the cost per click (revenue/number of clicks on the ads)
or the advertising revenue for 1000 page views.

Choosing the right financial ratios

As we mentioned in the introduction, there are many financial analysis ratios and it is appropriate
to select some relevant ratios to conduct your analysis. Thus, all the difficulty lies in
the good selection of ratios.

Here are some tips to help you choose the right financial analysis ratios:
• You start by studying what is done in your sector, what are the ratios used by my
competitors?
Example: in the e-commerce sector, there is a lot of talk about average cart size or conversion rate of
visitors.
• then you define what the key points of your activity are, what is really important
(the gross margin, the EBITDA,the markup rate, the taprofitability UX, payment deadlines...
Example: the gross margin is very important in trading and the revenue per employee ratio is very important in the
liberal activities
• Finally, it is important to retain relevant ratios in relation to the content of your financial statements.
(balance sheet, income statement...).
Example: no need to calculate a supplier payment period ratio if supplier debts are not
significant. On the other hand, the long-term debt repayment ratio (long-term debt/CAF) is
interesting when the company finances itself a lot through borrowing.

In summary: The balance sheet ratios

Published in the categoryThe analysis of the balance sheet

The ledger is an accounting document that contains data representing the calculation base
certain financial ratios. Compta-Facile dedicates a complete article that answers the questions: what
What are the ratios of the income statement? How to calculate them? What do they mean?
First of all, let's briefly recall what a financial ratio is. Thefinancial ratiosare tools that allow
to carry out a static financial analysis of a company. They relate two data points
and do not manifest a division. Regarding the balance sheet, there are many of them:
1. The ratioof autonomyfinancial
[Link] ratiodebtnet
[Link] current ratio
[Link] coverage ratio of stable jobs
[Link] depreciation ratio
6. Hybrid ratios
Furthermore, it is based on the balance sheet that the functional analysis is deployed, which technically allows for verification.
certain financial balances.

The main balance sheet ratios

The financial autonomy ratio

What is the financial autonomy ratio?
The financial autonomy ratio, also called the solvency ratio, measures the degree of importance
internal funding reported to total funding. It is expressed as a percentage and must, in
the practice, being at least 20%.
How to calculate a financial autonomy ratio from a balance sheet?
Calculating a financial autonomy ratio requires no prior adjustments. It is enough to observe
two lines of theliabilities of the balance sheetequity and total assets.
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 Financial autonomy ratio = Equity / Total balance sheet

The net debt ratio

What is the net debt ratio?
The debt ratio measures the weight of debt in relation to equity. It gives
an indication of the average debt ratio of an entity.
How to calculate a net debt ratio from a balance sheet?
Calculating a net debt ratio requires a prior calculation: that of net debt. It is
generally equal to the amount of bank and financial debts to which the amount of
advances in current accounts granted by the partners and subtract available funds and securities
placement (VMP). The second piece of information is obtained by consulting the liabilities on the balance sheet.
Ratiod’endettementnet=Net debtEquity

The current ratio

What is the current ratio?
The general liquidity ratio measures a company's ability to settle its short-term debts.
It mainly concerns its supplier debts, tax debts, and social debts.
How to calculate a current ratio from a balance sheet?
The calculation of a general liquidity ratio cannot be performed immediately. Two intermediate aggregates
must be calculated: current assets (inventory + accounts receivable) and current liabilities (accounts payable +
tax debts + social debts.
Current ratio=Current assets/ Current liabilities

The coverage ratio of stable jobs

What is the stable employment coverage ratio?
The stable employment coverage ratio measures the rate of coverage of fixed assets by
resources that the company has at its disposal sustainably, that is to say in the long term. It must,
preference, must be at least equal to 1.
How to calculate a stable employment coverage ratio from a balance sheet?
Calculating a stable employment coverage ratio requires two intermediate calculations:
• the calculation of permanent capital: equity + provisions for risks and charges + loans
with credit institutions + bond loans + blocked current accounts of partners
• the calculation of fixed assets: gross fixed assets - depreciation of tangible fixed assets and
intangible assets – depreciation of fixed assets
Stable employment coverage ratio =Permanent capital/ Fixed assets

The obsolescence ratio

What is the depreciation ratio?
The ratio of obsolescence measures the degree of aging of a company's productive apparatus. It is expressed in
percentage. Close to 100%, it means that the production tool is almost new. Otherwise, it
indicates that it is aging and will require a renewal more or less distant.
How to calculate a depreciation ratio from a balance sheet?
Calculating an obsolescence ratio is very simple. You just need to have two data points from the’balance sheet assets
accountantthe amount of net tangible assets (also called the’body assetwho appears
on a separate line of the asset) and the amount of gross tangible fixed assets (obtained by the calculation:
net tangible fixed assets + amortizations and depreciations applied.
Depreciation ratio = Net tangible assets / Gross tangible assets

The financial balance of the balance sheet

It is not about ratios in the strict sense, but rather a particular financial analysis known as
the functional analysis of the balance sheet. It is carried out based on a revised accounting balance sheet: abalance
functional. Its objective is to verify the financial balance of a company's balance sheet by ensuring:
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• that durable goods be financed at least by long-term resources;
• that the operating cycle is balanced and, conversely, financed by the surplus of resources
in the long term on durable goods;
• that the cash situation be positive.
These three balances are highlighted in financial indicators called respectivelyfunds of
net global rolling (FRNG)theworking capital requirement (WCR)and thenet treasury (NT).
Here is the detail of the calculation of the working capital requirement (its two components have been presented above):
Permanent capital - fixed assets
Here is the detail of the calculation of the working capital requirement (the calculation of current assets and current liabilities was also mentioned.
higher up in the article) :
BFR= actif circulant–passif circulant
Here are the details of the TN calculation:
TN= FRNG–BFR

Hybrid ratios
Some ratios draw their information from the two main financial statements: the balance sheet and the income statement.
of result. They are fundamentally important and have been detailed in a separate article. We
we invite our reader to refer to it if needed: the ratios.
These include the following ratios:
• Repayment capacityNet debt /Capacityself-financing
• Customer payment period: [AccountsReceivable / TotalRevenueIncludingTax] * 360
• Supplier payment term: [Supplier debts / Total purchases] * 360
• Inventory turnover time: [Average stock / purchase cost (or production cost)] * 360
• Return on equity:Net incomeEquity
Conclusion: the financial ratios derived from the balance sheet must be adapted to the nature of the activity carried out.
the company. It is important to be attentive to their selection and it is important to compare oneself.
over time (evolution of selected ratios) and in space (comparison of ratios with those
observed in companies in the same sector.

• The financial and economic analysis of a company

When one wishes to take over a company, it is necessary to conduct an analysis to ensure that the company is
the question is worth redeeming.

The analysis of a company is not limited to that of its financial statements (even if this is a step
important) but must expand to the study of its environment: the geographical sector, market analysis and
the clientele, the evolution of legislation...

One must proceed step by step to carry out the analysis of a company:
• The first involves studying the financial statements of the targeted company;
• Next, we will focus on the company's sector of activity: what is the market potential in which
Where is it located? A market study can prove useful;
• Afterward, the analysis of the company's geographical sector is also important;
• And finally, we will conclude on the evolution of the legislation in the sector and its respect by
the company.
This method of analyzing a company is certainly not unique and there are many of them, but it ...
is organized into different key stages of a business takeover.

The financial analysis of the company

The analysis of a company necessarily involves the analysis of its financial statements, regardless of its size.
or its activity. Can you imagine taking over a company that is suffering significant losses? That is in debt?
Who generates a very low turnover that does not cover the expenses?
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To conduct the financial analysis of a company, two elements are essential:
• the income statement, ideally over the past three years;
• and the balance, over the same period.
The study of these states should not be carried out by focusing on all the amounts they contain; it is necessary to identify the
significant elements that make up these financial statements. Then, these significant elements must be analyzed
in detail through other supporting documents.

We will not discuss the financial analysis of a company in detail as a complete work would be necessary.
The analysis of a company's balance sheet
The balance sheet of the company represents its assets, including everything the company has in its possession.
possession and all the debts it has in return (we also talk about jobs and resources).
The financial analysis of a company goes through the study of the following elements:

• The result of the current and previous exercises, which is found in the liabilities of the balance sheet: the company
Does it generate profit or incur losses?
• The equity of the company, which is located at the top of the liabilities on the balance sheet: equity
constitute a source of information on the value of a company. When dividends are
distributed each year, it is important to take this into account as these distributions decrease the amount of
equity
• The company's debt: here we need to analyze the company's debts, particularly the loans,
supplier debts, tax and social debts. A company that is too indebted risks
to have future cash flow problems.
• The company's fixed assets: are there many machines? Buildings? Patents? It
One must look closely at the fixed assets of the company because it contains important indicators.
like the date of investment realization: what elements will need to be replaced
coming soon?
• The available resources: this concerns the company's cash flow, is the company financially healthy?
or not?
B. The analysis of a company's income statement
The income statement is the summary of the company's operations over a given period, which includes
the total sales made and the expenses incurred.

The financial analysis of a company involves studying the following elements:

• The revenue generated in the latest fiscal years: is it increasing or decreasing?

how to explain its evolution?
• The company's margin: is it in line with industry averages? If not, what are the
reasons for this gap?
• The payroll: is it in line with what is practiced in the sector?
• The result of the exercise: This element has already been mentioned earlier. If the result is negative, one
will seek to identify the cost centers that are responsible and when it is positive, it
It is necessary to ensure that it is indeed due to the activity of the company.

The analysis of the company's resources

At this stage of analyzing a company, we will seek to provide answers to the questions.
following:
• What means does the company use to carry out its activity?

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 • Should the resources that the company possesses be replaced or is there a better method?
innovative, more productive?
• Will the teams in place in the company easily accept the change of direction?
Will they agree to change, if necessary, the procedures in place?
• Does the departure of the leader risk triggering the departure of one or more employees?
• What is the average age of employees, and are there imminent retirements to be expected?
The list of questions one might ask is of course infinite when analyzing the means of a
company. The main difficulty lies in being able to identify the key points to address for
analyze the company.

The subjects of reflection are indeed not the same depending on the size of the company, its organization, and its
sector of activity.

Previous experience in the business field of the analyzed company is advantageous for achieving
correctly carry out this step, it will facilitate the identification of key points to study.

The analysis of the company's market

As with starting a business, the acquisition must also undergo a market analysis.
the company.

The study of the supply and demand in the industry allows the buyer to:
• Ensure that there is indeed a market to exploit and analyze that the prospects for development are
encouraging, to avoid taking over a business in a declining sector;
• Analyze the company's clientele, their habits...
• To be interested in existing practices in this market and potential innovations;
• Gather information on the competition, the prices charged, the concentration of companies;
• Identify the needs of the population in the targeted area, their consumption habits, budgets
means for such or such service...
The entrepreneurs' corner offers you a specific article onthe studyof the market.

The analysis of the company's establishment

The analysis of a company also involves analyzing its geographical location.

Through this analysis, it is necessary to provide answers to the following questions:

• Why did the company establish itself here?
• Are there any potential future projects (reorganization, relocation of businesses...) that could pose a risk to
impair the functioning of the target company?
• Is this location optimal for exercising its activity?
Certain types of activities require, for example, to be in a dynamic downtown rather than in a beautiful area.
in the countryside, such as clothing stores or bars open at night.

The analysis of the legislation of the sector of activity

When analyzing a company, it is essential to pay attention to the legislation.

applicable to the sector and ensure that the company complies with it:
• Is the company compliant with hygiene and safety standards?

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 • Are the employees of the company properly trained to face the risks they are exposed to?
exposed?
• Does the company comply with the applicable environmental protection regulations?
These different points are essential for the buyer, as they allow for anticipating potential measures to
take to ensure compliance with legislation and, where applicable, quantify the cost.

Conclusion on the analysis of a company

The process of analyzing a company is therefore quite extensive, but it must be adhered to because the risk taken, especially
Financially, within the framework of a business takeover, it is much heavier than starting a business.