Financial ratios can be a relatively easy way to assess various aspects of a company's performance. Spanning profitability, liquidity, efficiency, stability and valuation, many of these ratios are very common, and when the results of these ratios are compared to other companies in the sector, or on the same company over time, they can be a simple yet powerful tool in uncovering the underlying progress of the company against peers. This short series of tutorials will look at different types of ratios, applying them to a specific company and then showing how comparisons could be made against rival companies in order to assess relative attractiveness. This tutorial will look at five core profitability ratios.
Financial ratios are most useful when comparing like-for-like companies. For these profitability ratios we will therefore look at two companies that are very similar in terms of operation: British American Tobacco (LSE:BATS) and Imperial Tobacco (LSE:IMT). Both of these companies is involved in the production of tobacco-based goods, primarily cigarettes, and operate on a global scale. I will demonstrate how to calculate each of these ratios for British American Tobacco and then compare it with the figure for Imperial Tobacco. We will use the 2014 results for British American Tobacco, which can be found here.
Bear in mind that there may be certain adjustments that need to be made to some of the numbers we use to better reflect the operating performance of the companies, but for simplicity we will ignore these for now and just seek to apply the formulae.