A guide to business finance and accounting—Part 2: Assessing financial health and how the markets will view performance
A guide to business finance and accounting—Part 2: Assessing financial health and how the markets will view performance

The following In House Advisor guidance note provides comprehensive and up to date legal information covering:

  • A guide to business finance and accounting—Part 2: Assessing financial health and how the markets will view performance
  • Assessing financial health: Financial ratio analysis
  • Return on Assets (ROTA)
  • Return on Equity (ROE)
  • Current ratio
  • Quick ratio
  • Interest cover
  • Debt/equity ratio
  • How the stock market views your performance

Assessing financial health: Financial ratio analysis

Assessing the financial health of a business means posing some key questions, for example:

  1. how profitable is the company?

  2. how liquid is the organisation?

  3. how solvent is the company?

Ratio analysis is a useful way of understanding the dynamics of a company’s sourcing and use of funds. As such, they are valuable pieces of information and we will therefore go into details on the different ratios and how to calculate them. Their value mainly lies in their comparison with the equivalent ratio in previous years, a target ratio or a competitor’s ratio. We will use the financial accounts of a fictitious company, Enterprise plc, shown in Section 2 to illustrate the use of some of the more important ratios.

Assessing Profitability

Assessing corporate profitability involves looking at the relationship between profit and the assets used to generate that profit. Two ratios are important in this connection.

Return on Assets (ROTA)

ROTA focuses on what return has been generated on the investment in total assets. The ratio for Enterprise plc is:

Earnings Before Interest and Tax (EBIT)/Total assets (TA)

60/400 = 15%

ROTA provides a benchmark against which operations management can be measured. Its usefulness can also be enhanced by drilling down to its two subsidiary ratios, profit margin and asset turnover, which in the case of Enterprise plc are as