UNIT 2 INDIVIDUAL PROJECT 2 - Essay Example

Running Header: Ratios for Financial Services Company Financial Ratios from Lender and Investor perspective Financial Ratios – Investor and Banker Financial Analysis is an important aspect of investing. In particular ratio analysis is an important technique used in analyzing financial statements. Ratios reveal the relationship between the financial numbers for meaningful interpretation. Ratio analysis is the systematic use of ratios to interpret financial performance of a company. There are different types of ratios used for different interpretations.

In this paper, we discuss four ratios that are considered important for a financial services firm from an investor and a banker’s perspective.Apart from the external short and long-term creditors of the company, the investors and lender’s interested in a company consider ratios as an important indicator for decision making. The investors look to measure the capacity of the firm to provide them with adequate return on their investment. Similarly banker’s who look to lend money or advance money to any firm would use the below ratios to assess the capacity of the borrower firm to repay the debt.1) Net Profit Ratio 2) Debt Service Coverage Ratio (DSCR)3) Return on Investment (ROI)4) Earnings per Share (EPS)Net profit Ratio = Earning after tax / Sales (Servicing Revenue)As we know the primary purpose of every firm is to maximize shareholder’s wealth.

The bottom line of the company is the prime focus for both the management and the external investors / lenders of the company. Thus, the net profit ratio helps us understand the percentage of net profit after all expenses to the total revenue of the company. It is an indicator of how well the company’s management has worked not only towards accelerating revenues, optimizing costs including cost of borrowed funds but also providers the owners an understanding that there would be adequate return on their capital employed.

A higher net profit would mean adequate returns to the shareholders and the lenders.Debt-Service Coverage Ratio = Earnings before Tax /(Interest + Principal Payment)“Debt-Service Coverage Ratio” is an important ratio for every banker or lender who is looking to finance or provide funds as borrowings to the company. This ratio is indicative of the capacity of the company to make enough earnings before tax to ensure that the loan is being serviced. In other words, the ratio (if above 1.5) indicates that the organization makes enough earnings to repay interest and principle payments of the funds borrowed on a monthly basis.

Indeed, the banker or the lender considers this ratio as a prime indicator of the capacity of the firm to repay back the debt that they fund.Return on Capital employed (ROCE) = (Earnings after tax / EBIT) X 100 (Average Total Capital employed)ROCE is one of the important ratios used to understand the return on investment or capital employed. The term capital employed means long term funds supplied by creditors and owners of the firm. This ratio helps in measuring or testing the profitability of the company against the sources of the long-term funds to understand the percentage of return that the owners get for their capital.

The higher the ratio, the better it is. But this ratio as a stand-alone factor cannot be used for any decision-making. Ideally this ratio is compared to the ROCE of the industry or competitor firms to understand the performance of the company. This ratio as mentioned is extremely important from an investor’s perspective.Earnings per Share (EPS) = Earnings after tax / Total number of outstanding equity shares Earnings per share or popularly knows as EPS is an important ratio from an equity investor’s perspective.

Dividend is the source of income or return for an equity investor. Assuming the firm comes out with an initial public offering, every investor looking to invest capital in the firm would base his or her decision on the earnings that they would receive for every stock they invest in. This ratio is directly depended on the ability of the management of the company to optimize costs, increase revenues and accelerate their net profit to maximize the shareholder’s wealth. It is also good to understand that Net profit and EPS are also factors that impacts the price of the company’s common stock being traded in the stock exchange.

References1) Hampton J.J., “Financial Decision Making – Concepts, Problems & Cases”, Fourth Edition, (Prentice Hall), 2004 2) Fridson M, Alvarez F, “Financial Statement Analysis: A practitioner’s guide”, Third Edition, (John Wiley & Sons), April 2002