Dozens of different financial ratios exist. In fact, Cube Software acknowledges 50, describing them as ‘the only financial ratios you’ll ever need’.
Generally, the most used financial ratios include the following:
The above ratios offer a comprehensive overview of a company’s (present) financial position.
Yet, they don’t represent every nuance of a company’s financial health. Analysts can plumb deeper into their company’s past, present and future financial health by leveraging lesser-known ratios.
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This article reflects a collaboration between our financial data team’s expertise and our work building AI financial models.
Calculating the Cash Conversion Cycle (CCC) may not be as trendy as calculating current ratios. Nonetheless, the CCC is an essential liquidity metric for calculating how quickly your company can convert inventory into cash.
Provided you have your company financials in front of you, you can calculate this ratio quickly by:
Adding Days Inventory Outstanding (DIO) and Days Sales Outstanding (DSO) before subtracting Days Payable Outstanding (DPO).
Suppose you’re calculating the CCC as a one-off. In that case, you can upload the financial document to an AI virtual assistant like ChatGPT and ask it to calculate it. (Don’t forget to check its findings, as AI virtual assistants still hallucinate ~1% of the time).
Alternatively, you can prompt the AI to benchmark the CCC across the company's competitors. You will likely need to upload their publicly listed financials manually. However, AI virtual assistants may struggle to source and extract their data online.
The Free Cash Flow Yield (FCFY) is a key ratio for evaluating stocks and helping investors make informed decisions. While many investors will favour price-to-earnings (P/E) ratios, P/E ratios are susceptible to earnings manipulation. Consequently, investors who rely solely on P/E ratios may not get a true picture of a company's financial health.
We recently wrote about the 2001 Enron scandal, where energy company Enron went bankrupt amid a media storm. Enron is a classic example of earnings manipulation. Their stock was heavily overpriced as a direct result of them inflating their reported earnings.
Perhaps if the auditors had deployed an FCFY calculation, they would have been able to identify the massive shortfalls more quickly.
To calculate the FCFY, divide the Stock Price by the Free Cash Flow per Share. Again, it is not difficult to calculate, but AI has plenty of scope to enrich the analysis process. It can do so by identifying free cash flow stability and earnings manipulation.
You can leverage AI in several ways to understand FCFY’s implications. For instance, to determine cash flow consistency quickly, you could upload free cash flow data and let the AI virtual assistant assess whether the FCFY is stable or volatile.
Or, to accelerate earnings vs. Cash Flow Comparison, prompt ChatGPT to compare net income trends vs. FCFY trends to detect earnings manipulation. You can do this by uploading either the data or the financials directly.
Interest coverage ratio (ICR) trend analysis measures a company’s ability to pay its interest payments using its operating income. Instead of looking at a single period, tracking the ICR trend over multiple quarters can reveal if a company is gradually becoming overleveraged.
It also provides a more nuanced overview of a company's stability than profitability. A declining ratio may indicate increasing financial risk and, eventually, a default (even if the company remains profitable).
You could ask an AI virtual assistant to identify trends from uploaded financial statements. Or, use it to generate a Python script or Excel formula to automate ICR trend tracking if you wish to automate this process or have a large volume of data.
Though these financial ratio strategies won’t apply to every use case, their potential is undeniable in promoting transparent financial assessment and reporting.
The rise of AI technologies means that calculating these financial ratios (plus related analysis) is quicker than ever. Note that an AI virtual assistant’s lack of specialisation means you will inevitably encounter hallucinations. So, considering a specialised solution may be in order.
Financial Statements AI is our dedicated financial statement extraction tool. When the user uploads financial statements, Financial Statements AI ‘reads’ them, extracting all the line items. Then, it calculates key financial metrics using the extracted data.
In essence, Financial Statements AI prepares the input metrics to calculate the financial ratio of your choice. It shaves off the tedious parts of financial analysis – extracting, structuring and calculating the foundational data – giving you the important insights, faster.
Book a free demo to try Financial Statements AI today, or email our team at hello@evolution.ai.
