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Encyclopedia of Financial Models, 3 Volume Set by Frank J. Fabozzi

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Financial Ratio Analysis

PAMELA P. DRAKE, PhD, CFA

J. Gray Ferguson Professor of Finance, College of Business, James Madison University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor of Finance, EDHEC Business School

Abstract: Financial analysis involves the selection, evaluation, and interpretation of financial data and other pertinent information to assist in evaluating the operating performance and financial condition of a company. The operating performance of a company is a measure of how well a company has used its resources—its assets, both tangible and intangible—to produce a return on its investment. The financial condition of a company is a measure of its ability to satisfy its obligations, such as the payment of interest on its debt in a timely manner. The analyst has many tools available in the analysis of financial information. These tools include financial ratio analysis and quantitative analysis. The analyst must understand how to use these tools, along with economics and accounting information, in the most effective manner.

Financial analysis is one of the many tools useful in valuation because it helps analysts and investors gauge returns and risks. In this entry, we explain and illustrate financial ratios—one of the tools of financial analysis. In financial ratio analysis we select the relevant information—primarily the financial statement data—and evaluate it. We show how to incorporate market data and economic data in the analysis of financial ratios. Finally, ...

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