According to an essay by Michael C. Dennis published on the Anscers website, a ratio is simply a mathematical relationship between two numbers. Investors, creditors, bankers and other stakeholders use financial ratios to chart a company's progress, uncover trends and point to potential problem areas. According to Dennis, the following ratios would be helpful in evaluating NUMMI:
1. Liquidity Ratios: These ratios indicate the ease of converting current assets into cash. Liquidity involves a company's ability to meet current obligations. Liquidity ratios include the Current and Quick Ratio.
The Current Ratio formula is: Current Assets divided by Current Liabilities. The current ratio measures financial liquidity. The Quick ratio formula is: Cash plus Cash Equivalents plus Accounts receivable divided by current liabilities. It is a more strenuous version of the current ratio since it offers insights about whether NUMMI's current liabilities could be paid without selling inventory.
Leverage ratios measure the relative contribution of stockholders and creditors. A Leverage ratio indicates the extent to which NUMMI relies on debt rather than equity. One such ratio is the Debt to Equity ratio. The formula is: Total liabilities divided by Total equity. This ratio indicates how highly a company is leveraged. A high debt to equity ratio could mean NUMMI will have trouble paying its long term debts.
The interest coverage ratio formula is: Earnings before Interest, Taxes, Depreciation and Amortization. divided by Interest Expense. This ratio indicates what portion of debt interest is covered by NUMMI's cash flow. It is another measure of financial leverage.
Profitability ratios measure a company's ability to generate revenues and profits. The Return on Sales formula is: Net profit divided by Sales. This ratio compares after tax profit to sales. It can help an analyst determine if NUMMI is making an adequate return on...