Analyze key financial ratios of technology companies

The technology sector is an industry composed of companies (and related stocks) engaged in R&D and/or distribution of technology-based goods, services, and products. This department includes companies that manufacture electronic products and create software; manufacture, market, and sell computers and products related to information technology.

The unique thing about technology companies is that they usually have almost no inventory; they are usually unprofitable and may not earn revenue. In addition, many technology companies invest heavily in venture capital or issue large amounts of debt to fund research and development.

The strategy of technology companies is usually different from that of other companies, because many companies seek to be acquired instead of generating profits. Therefore, key financial ratios are used when analyzing a technology company.

Key points

  • Unlike companies in other business areas, technology companies often seek to be acquired.
  • Financial ratios such as liquidity, profitability, and financial leverage can help investors analyze technology companies.
  • The current ratio, which is calculated by dividing current assets by current liabilities, is the most commonly used current ratio.
  • The debt-to-equity financial leverage ratio measures how much a company has compared to its total equity.

Liquidity ratio

The liquidity ratio provides information about the company’s ability to meet short-term obligations. Since many technology companies are not profitable or even generate revenue, it is important to analyze a technology company’s ability to meet its short-term financial obligations.

Current ratio

This ratio is the most common liquidity ratio that measures a company’s ability to pay short-term financial obligations. It is also the least conservative of the liquidity ratios. In the technology industry, it is important to have a high current ratio because companies usually need to fund all their operations from current assets, such as cash received from investors.

Current ratio = (current assets/current liabilities)

Cash ratio

The cash ratio is the most conservative of all liquidity ratios, making it the most difficult indicator of whether a company can meet its short-term obligations. This is the most important liquidity ratio for a technology company because the company usually has only cash and no other liquid assets (such as inventory) to fulfill its current obligations.

Cash ratio = (cash + marketable securities)/current liabilities)

In addition, technology companies may own a large number of marketable securities through acquisitions and investments, and these securities should be included in the liquidity calculation.

Financial leverage

Contrary to the liquidity ratio, the financial leverage ratio measures a company’s long-term solvency. These types of ratios take into account long-term debt and any equity investment, both of which have a significant impact on technology companies.

Debt to equity ratio

The debt-to-equity ratio is extremely important for the analysis of technology companies. This is because technology companies have made substantial investments in other technology companies and have obtained investment and debt from other organizations to provide funding for product development.

Debt-to-equity ratio = (total debt)/(total equity)

When a technology company decides to acquire another company or fund necessary R&D, it usually does so through external investment or bond issuance. When stakeholders analyze a technology company, it is important to look at the amount of debt that the company has issued. If the ratio is too high, it may mean that the company will become insolvent before it makes a profit and repays its debts.

Profit ratio

Although many technology companies are not profitable initially, even large companies like Amazon need to look at their profit margins; other ratios, such as gross profit margin, are good indicators of future profitability even if they do not have current operating profits.

Gross profit margin

Gross profit margin = (net sales-cost of sales) / net sales

This profit margin measures the gross profit from sales. It only applies to situations where technology companies are generating revenue, but high gross margins are a signal that once the company expands, it can become very profitable. Low gross profit is a signal that the company cannot make a profit.

.

READ ALSO:   Absorption cost
Share your love