When you get the balance sheet of 2 companies that you want to compare the first thing you do is to make sure that both are in the same language! So if you are comparing Toyota Motors, Form Motors, and Tata Motors – you need to bring them all to US $, and then start comparing.
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| Capitalstars Investment Advisor |
Also, it is unfair to compare companies of different sizes, because it makes no sense. So you will have to bring them to the “the same size” by converting all the numbers to a %age. Then you will be able to compare the same. That is the starting point.
Another thing you can do is to compare the ratios. Ratios, of course, have no units – the units in the numerator cancel the units in the denominator! You may have heard of words like “P/E ratio,” “current ratio” and “operating margin.” In fact, you cannot miss them if you are a TV watcher or a pink paper reader. However, what do these terms mean and why can you not find them in the annual reports? Here are some of the many ratios that investors calculate (should calculate?) from information on financial statements and then use to evaluate a company. When you are looking at different industries or at different aspects in the same company you use different ratios.
Companies have ratios split into
a) balance sheet ratios
b) Profit and Loss ratios
c) solvency ratios and d) activity ratios
Ratios are used not only to compare across companies but also across the same company for different points in time. So a Q1 can be compared to Q2 or Q1 to the total for the year….as you wish.
If a company has said a Debt: Equity ratio of 2:1 it means it has Rs. 2 of borrowing for every rupee that it owns. What is owns is what we called ‘shareholder’s funds’ – it is the capital that the shareholders put, the premium, and the undistributed profits. Borrowing is the total money that it owes outsiders.
This was just a glimpse……tons of work to be done in understanding Financial ratios. Go pick up a book on Finance….