Saturday, December 09, 2006

Financial Ratios

Interestingly, after a long two and half years of studying for MBA program has not made any better understanding of the financial ratios. Most interesting thing I saw was every finance course we keep doing ratios to land up into the same discussion in the subsequent classes. Here was the classic one. The ratios on returns. RoI, RoA, RoCE, RoE and god knows what all. I use a very common sense approach to ratio determination as such.

There are stakeholders who have put in money or provided infrastructure for a company to operate and they expect some tangible gains from the company. Whatever they gain is basically return. That being said who are the stakeholders to a company?
  1. Equity holders (Both preferential and common stocks)
  2. Debt holders
  3. Government

There are 3 kinds of basic gains for each of the stakeholders

Equity holders get residual profits, Debt holders interest and Government Taxes.

Hence return on asset should consider total returns on the complete asset so return definition here is PBIT. While for Return on Equity it should just be the PAT. Returns are worked on accrual basis and never on expensed basis.

In any case, after all we are MBAs and we will democratize the process of finding the obvious as well and will not know but think it might be something or in the end say well then everything is right. After all the world was there before accounting standards came into being.