- 1). Calculate the necessary financial ratios based on the company's audited financial statements. When analyzing a company, you should calculate the following financial ratios:
Inventory Turnover = Cost of Sales / Average Inventory
Accounts Receivable Turnover = Revenue / Average Accounts Receivable
Accounts Payable Turnover = Cost of Sales / Average Accounts Payable
Asset Turnover = Sales / Average Total Assets
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Current Assets -- Inventory) / Current Liabilities
Debt to Equity = (Short-Term Debt + Long-Term Debt) / Stockholders' Equity
Interest Coverage = Operating Income / Interest Expense - 2). Calculate the ratios for three years and compare current and historical numbers. For example, if the company's inventory turnover ratio is decreasing from year to year, it means that the company is not selling its inventory as quickly. This trend is worrying, since it may mean that the company is not producing products that people want, and it may lead to a cash flow shortage. By contrast, if the company's current ratio is getting bigger over time, it means the company's current assets are growing faster than its current liabilities. This trend is a positive one, since it means the company has enough assets to meet its short-term financial obligations.
- 3). Compare the company's financial ratios calculated in Step 1 to the ratios of other companies in the same industry. You can calculate the financial ratios for each of the company's main competitors, or you can get the information from Google Finance. Enter the company's ticker symbol in the Google Finance search box, and then select the "Key Ratios" link on the left side of the new page. The link will take you to a page showing the financial ratios for the industry in which the company you are analyzing operates.
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