10 valuable financial ratios for strategic analysts
Analysis of a firm’s financial statements proves valuable to strategists. The most valuable financial analysis interprets results as ratios, one thing
divided by another. When doing financial ratio analysis in a strategy context, analysts focus on those ratios that speak to the firm as a whole, and
look at ratios with long-term implications for the operation of the business. Specifically, there are four things to keep in mind:
1. Look for ratios that tell you how a firm is performing with its current strategy. Financial performance tells you how well a company’s
strategy fits in its environment, and it tells you how well the company is doing in implementing that strategy. Be careful to distinguish
between a firm’s ongoing operations and special one-time results (such as a charge-off, reserve expense, or windfall return).
2. Look for ratios that tell you how much flexibility (capacity or slack) a firm has to grow and/or change its strategy. A firm may be
performing well today but have little slack, or unused capacity to deal with changes in the environment, competitive moves, or the
ability to capitalize on new growth.
3. The best analysis is comparative—how does the firm compare to its closest rivals? Other industry participants? With itself over time?
Ratios mean little in themselves. For example, is a 15% gross margin good? If you are a grocer, probably, but if you are a tech company
that may be horrible. Ratio analysis only makes sense when you can compare the firm to a benchmark. Good benchmarks include the
best firm in the industry, the firm’s closest competitor, the average firm in the industry, or the firm’s historical performance.
4. Financial analysis only measures returns to shareholders and/or debtholders. Financial reports don’t usually shed much light on a how
firm treats its employees, do they earn fair returns in wages and benefits? How about customers, do they receive quality products at a
fair price? How about suppliers or communities? In short, financial performance and analysis matters, but remember that shareholders
are only one stakeholder and the firm must provide value to multiple stakeholders if it is to create and sustain a competitive advantage.
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10 valuable financial ratios for strategic analysts
Ratio
Performance ratios
Net Profit Margin
Gross Margin
Return on assets
Return on Equity
Return on Invested Capital
Productivity
How to derive it
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝑆𝑎𝑙𝑒𝑠
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦
𝑆𝑎𝑙𝑒𝑠
# 𝑜𝑓 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
# 𝑜𝑓 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠
What is measures
Why it matters
The final financial return of the
business, after operations, financing,
and taxes have been factored in.
The true bottom line of a business.
Answers the very simple question: How
profitable is the company?
The profitability of the firm’s
products or services, including only
direct costs.
Helps strategists understand the how
variable costs influence profitability.
The returns earned by the assets
employed by the firm.
How efficiently the firm uses the assets it
has control over.
The returns to current stockholders
of the firm.
How efficiently the firm uses the equity
capital under its control.
The returns to providers of both
equity and debt.
How efficiently the firm uses all types of
financial capital under its control.
The amount of top-line revenue
generated per employee.
The efficiency of the firm’s human capital
in generating sales.
The amount of profit generated per
employee
The efficiency of the firm’s human capital
in generating profits.
The operating performance of the
firm, net of financing, tax, and
accounting treatments.
The financial resources the firm can use for
Capital Investments, taking on borrowing,
funding acquisitions, etc.
1. Slack measures
EBITDA
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
+ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
+ 𝑇𝑎𝑥 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
+ 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛
+ 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑜𝑛
Debt to Equity
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
The total leverage of the firm, or the
relative contribution of debt capital
in the overall capital structure.
The higher the D/E ratio, the less willing
providers of debt will be to finance growth
or change.
Long-Term D/E
𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐷𝑒𝑏𝑡
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
The leverage of the firm’s long term
capital structure
LT D/E provides the same basic information
as D/E; the value comes in comparing the
two numbers as it tells you how levered the
firm is in meeting short term vs. long term
commitments.
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10 valuable financial ratios for strategic analysts
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