Cash Flow Ratios For Investing - 2036 Words

As an investor or shareholder, one needs to learn and know how to calculate financial ratios before investing, otherwise an investor may risk investing in a debt filled firm with low profitability. Financial ratios are primarily tools for turning the data contained in financial statements into information used by managers and executives to better understand what is happening in a company. Like all tools, they can be used for things other than their original design, such as evaluating an acquisition, creating pro-forma statements related to potential courses of action, or figuring out which stock to buy. Cash flow ratios measure how much cash is generated and the safety net that cash provides to the company to finance debt or grow the†¦show more content†¦Generally speaking, investors are more confident in putting their money in riskier options. Financial ratios help investor in determining the financial health of an organization (Lai Ping-Fu Cho Kwai-Yee, 2016). The most i mportant ratios to a bond investor in a corporate bond issuance fall under the liquidity, solvency and profitability ratios. Profitability is the ability of a firm to generate earnings (Gibson, 1987). Liquidity ratios have the ability to be quickly converted to cash without losing significant value. Liquidity refers to the company’s ability to access cash in order to pay its short term obligations (Gibson, 1987). They include current ratios, acid test ratio, and operating cash flow per share among others. The bond investor needs to know the acid test ratio because it shows whether a company has enough short-term assets to cover its immediate liabilities without selling inventory (Mahboobinejad, 2015). The higher the acid test ratio, the safer a position the company is in (Gibson, 2013). The acid test is very similar to the current ratio except that it excludes inventory because inventory is often illiquid (Gibson, 2013). The nature of the inventory and the industry in which the company operates will determine if the acid test or the current ratio is more applicable. Acid test = Current Assets – Inventory/ Current Liabilities. Price /earnings ratio - investors view the P/E ratio as a gauge of future earning power of the firm.