Here are the ratios that I learned today:
Mrs. Spurgeon likes the lo-tech method of gathering information on sticky notes and posting them to her wall, so I’m going along with it.
If you couldn’t see them clearly, here they are:
Debt to equity
Current ratio
Return on equity
Net profit margin
Debt ratio
Return on sales
Asset turnover
Quick ratio
And these are only a few. There are over a hundred ratios that are used in the financial world, but I am more focused on making sure that I know these ratios in particular for now, as these are the most applicable ratios to a nonprofit organization evaluating a business opportunity.
They all seem simple, and it looks like they all have a quick and easy formula, but they’re actually more difficult than they seem. Each ratio has its own nuances and terminology associated with it. For example, for the return on equity ratio, the formula is net income divided by equity, but in order to understand how exactly the ratio works, I had to learn what equity was and what net income was, and there was even more behind those two terms.
The most difficult of these financial ratios were the current ratio, the debt to equity ratio, and the return on equity ratio. I began my day studying these financial ratios with Mrs. Spurgeon. Again, each formula isn’t hard to understand, but what’s behind the ratio is more important and can be tricky at first. We discussed what each ratio measured (which often led to more “What’s that?” questions) and the reasons for using each ratio. Everything makes sense when applying it to an example. For instance, let’s say we want to evaluate Company A’s current financial health. We could use the current ratio, which is determined by dividing current assets by current liabilities. A current asset is a source of financial value that will soon become cash, and a current liability is some sort of obligation that I will soon pay with cash. This is a good ratio to evaluate current financial health because it only involves the amount of soon-to-become cash and the amount of cash that is soon-to-be-paid-with. In other words, because one only looks at short-term transactions, it shows how an organization or business is doing at the current time. This doesn’t necessarily mean that a higher current ratio is necessarily better than a lower current ratio in the long term, but it’s basically a way of evaluating if an organization or business is able to currently operate without running into trouble in the short-term.
I researched the other ratios listed above by using resources that I found online. After learning the first three ratios, the rest of them weren’t too difficult. I supplemented all of the material I learned today by watching several videos that, once again, explained each ratio, gave a reason for using it, and put it into use with an example.
Although it didn’t seem like I learned a lot today, Mrs. Spurgeon reminded me that all of what I learned today was new, and what you see in the picture was not everything I learned. I also went through applications of each of the ratios and made up my own examples (and checking with Mrs. Spurgeon) to make sure that I understood the trickier concepts. All of the ratios were abstract concepts, and when I was learning them, I could only understand them when I could give them some context.
Additionally, it is important to note that I have simplified some of the concepts that I wrote about in this blog post. However, these simplifications do not change the essence of any concept being discussed, and these simplified explanations will most likely be enough for me to create my financial model.
By the end of the day, I felt a lot better with these ratios, and I am now curious to see how these ratios will affect my research for model and the actual building of the model.
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