Analytical Tools in Financial Modeling

Financial ratios are tools for interpreting financial statements to provide a basis for valuing securities and appraising financial and management performance.

A good financial analyst will build in financial ratio calculations extensively in a financial modelling exercise to enable robust analysis. Financial ratios allow a financial analyst to:

• Standardize information from financial statements across multiple financial years to allow comparison of a firm’s performance over time in a financial model.
• Standardize information from financial statements from different companies to allow an apples to apples comparison between firms of differing size in a financial model.
• Measure key relationships by relating inputs (costs) with outputs (benefits) and facilitates comparison of these relationships over time and across firms in a financial model.

In general, there are 4 kinds of financial ratios that a financial analyst will use most frequently, these are:

• Performance ratios
• Working capital ratios
• Liquidity ratios
• Solvency ratios

These 4 financial ratios allow a good financial analyst to quickly and efficiently address the following questions or concerns: