[Opinion] Role of Financial Ratios in Improving Transparency & Empowering Investors

Financial ratios are a tool used to evaluate the performance and financial health of a business. The importance of ratios has increased after the amendment to Schedule III to the Companies Act, 2013 which requires companies to disclose financial ratios in their annual report. These ratios include liquidity ratios, solvency ratios, efficiency ratios, and profitability ratios, to gain insight into the company’s financial health, operational efficiency, and profitability. BSE also allows companies to disclose the below-discussed ratios on its website.

This requirement not only increases transparency in financial reporting but also helps investors make informed investment decisions. With the easy accessibility of financial ratios, investors can quickly compare a company’s performance against industry benchmarks, assess its financial health, and evaluate its ability to meet its financial obligations. Additionally, it can help identify potential risks and opportunities that may impact the company’s future financial performance. As such, the disclosure of financial ratios is a crucial step towards building trust and confidence among investors and stakeholders.

1. Operating Margin Ratio (OPM %)

Operating margin, also known as operating profit margin or return on sales, is a financial metric that measures a company’s operating income as a percentage of its revenue. It represents the amount of profit that a company makes before taking into account taxes and other non-operating expenses, relative to its sales.

A high operating margin indicates that a company is efficiently managing its costs and generating significant profit from its operations. Conversely, a low operating margin may suggest that a company struggles to control its expenses or faces strong competition.

2. Net profit Margin Ratio (NPM %)

Net profit margin ratio, also known as net margin or net income margin, is a financial metric that measures the profitability of a company by calculating the percentage of its revenue that represents its net income or profit.

Net income is the profit that a company earns after all expenses, including taxes and interest, have been deducted from its revenue.

A high net profit margin ratio indicates that a company is generating a significant amount of profit relative to its revenue. It is a key indicator of a company’s financial health and can be used to compare the profitability of companies within the same industry. Conversely, a low net profit margin ratio may suggest that a company is facing financial difficulties or is not effectively managing its costs.

3. EPS

EPS stands for “Earnings per Share” and is a financial metric used to measure a company’s profitability on a per-share basis. EPS is calculated by dividing a company’s net income by the number of outstanding shares of common stock.

Net income is the company’s total profit after all expenses, taxes, and interest payments have been deducted. Preferred dividends are the amount of dividends paid to preferred stockholders, which must be subtracted from net income before calculating EPS. Average outstanding shares represent the average number of shares of common stock outstanding during a specific period.

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