How to Analyze a Company Using Financial Ratios and the Financial Modeling Prep API

Analyzing a company is essential whether you're an investor, a business owner, or just curious about how a business operates. One of the best ways to understand a company's health is by using financial ratios. In this article, we'll walk you through the basics of company analysis, explain key financial ratios, and show you how to use the Financial Modeling Prep (FMP) API to get the data you need.

Why Analyze a Company?

Before diving into numbers, it's important to understand why analyzing a company matters:

• Investment Decisions. Helps you decide whether to buy, hold, or sell a stock.
• Performance Tracking. Measures how well a company is doing over time.
• Comparing to closest peers. Pick great stocks based on peer analysis.

Understanding Financial Ratios

Financial ratios are simple calculations that help you evaluate different aspects of a company's performance. They need to be compared to the company's closest peers and also examined individually to see how strong the company is. They are divided into several categories:

1. Liquidity Ratios. These ratios measure a company's ability to pay its short-term debts.

• Current Ratio = Current Assets ÷ Current Liabilities

This ratio shows how many dollars in current assets are available to cover each dollar of current liabilities.

Example: If a company has $200,000 in current assets and $100,000 in current liabilities, the current ratio is 2.0. This means the company has $2 for every $1 it owes in the short term debt.

• Quick Ratio (Acid-Test Ratio) = (Current Assets - Inventory) ÷ Current Liabilities

This ratio provides a more stringent measure than the current ratio by excluding inventory, which may not be quickly convertible to cash.

Example: If a company has $200,000 in current assets, $50,000 in inventory, and $100,000 in current liabilities, the quick ratio is (200,000 - 50,000) ÷ 100,000 = 1.5. This means the company has $1.50 in liquid assets for every $1 it owes.

• Cash Ratio = Cash and Cash Equivalents ÷ Current Liabilities

This is the most conservative liquidity ratio, measuring only the most liquid assets.

Example: If a company has $80,000 in cash and cash equivalents and $100,000 in current liabilities, the cash ratio is 0.8. This means the company has $0.80 in cash for every $1 it owes.

2. Profitability Ratios. These ratios show how well a company is generating profit.

• Net Profit Margin = Net Income ÷ Revenue

This ratio indicates how much profit a company makes for every dollar of revenue.

Example: If a company makes $50,000 in profit from $200,000 in sales, the net profit margin is 25%. This means the company keeps $0.25 from every $1 of sales after all expenses.

• Return on Assets (ROA) = Net Income ÷ Total Assets

ROA measures how efficiently a company uses its assets to generate profit.

Example: If a company earns $100,000 in net income and has $500,000 in total assets, the ROA is 20%. This means the company generates $0.20 in profit for every $1 of assets.

• Return on Equity (ROE) = Net Income ÷ Shareholders' Equity

ROE indicates how effectively a company uses shareholders' equity to generate profit.

Example: If a company has $100,000 in net income and $400,000 in shareholders' equity, the ROE is 25%. This means the company generates $0.25 in profit for every $1 of equity.

3. Leverage Ratios. These ratios assess how much debt a company is using to finance its assets. High leverage can indicate higher risk.

• Debt-to-Equity Ratio = Total Debt ÷ Shareholders' Equity

This ratio shows the proportion of debt a company is using relative to its equity.

Example: A debt-to-equity ratio of 1.5 means the company uses $1.50 in debt for every $1 of equity.

• Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) ÷ Interest Expenses

This ratio measures a company's ability to pay interest on its debt.

Example: If a company has an EBIT of $150,000 and interest expenses of $50,000, the interest coverage ratio is 3.0. This means the company earns $3 for every $1 of interest expense.

• Debt Ratio = Total Debt ÷ Total Assets

This ratio indicates the percentage of a company's assets that are financed by debt.

Example: If a company has $300,000 in total debt and $600,000 in total assets, the debt ratio is 0.5 or 50%. This means half of the company's assets are financed by debt.

4. Efficiency Ratios. These ratios evaluate how effectively a company uses its assets and manages its operations.

• Asset Turnover Ratio = Revenue ÷ Total Assets

This ratio measures how efficiently a company uses its assets to generate sales.

Example: If a company generates $300,000 in sales with $150,000 in assets, the asset turnover ratio is 2.0. This means the company generates $2 in sales for every $1 of assets.

• Inventory Turnover Ratio = Cost of Goods Sold (COGS) ÷ Average Inventory

This ratio shows how many times a company's inventory is sold and replaced over a period.

Example: If a company has a COGS of $400,000 and an average inventory of $100,000, the inventory turnover ratio is 4.0. This means the inventory turns over four times a year.

• Receivables Turnover Ratio = Net Credit Sales ÷ Average Accounts Receivable

This ratio measures how effectively a company collects its receivables.

Example: If a company has net credit sales of $500,000 and average accounts receivable of $50,000, the receivables turnover ratio is 10.0. This means the company collects its receivables ten times a year.

5. Market Ratios. These ratios relate to the company's stock performance.

• Earnings Per Share (EPS) = Net Income ÷ Number of Outstanding Shares

EPS indicates the portion of a company's profit allocated to each outstanding share of common stock.

Example: If a company earns $100,000 and has 10,000 shares, the EPS is $10. This means each share earns $10.

• Price-Earnings Ratio (P/E) = Market Price per Share ÷ Earnings Per Share

The P/E ratio shows what the market is willing to pay for a company's earnings.

Example: If a company's stock is priced at $50 and its EPS is $10, the P/E ratio is 5. This means investors are willing to pay $5 for every $1 of earnings.

• Dividend Yield = Annual Dividends per Share ÷ Market Price per Share

This ratio measures how much a company pays out in dividends each year relative to its stock price.

Example: If a company pays $2 in annual dividends per share and the stock price is $40, the dividend yield is 5%. This means investors earn a 5% return from dividends alone.

Using the Financial Modeling Prep API for Financial Ratios

Gathering accurate financial data is crucial for calculating these ratios. The Financial Modeling Prep (FMP) API provides easy access to a wealth of financial information, including financial ratios.

I. Here's how you can use it with API request:

Step 1: Sign Up for the FMP API

First, visit the Financial Modeling Prep website and sign up for a free account. Once registered, you'll receive an API key that you'll use to access the data.

Step 2: Choose the Financial Ratios Endpoint

The FMP API offers various endpoints for different types of data. For financial ratios, you'll use the Ratios API endpoint. This endpoint provides a range of ratios for a specified company.

Step 3: Make an API Request

To get financial ratios for a company, you'll need its stock ticker symbol. For example, let's use Apple company whose ticker symbol is AAPL.

Here's a sample API request URL:

https://financialmodelingprep.com/api/v3/ratios/AAPL?period=quarter&apikey=YOUR API KEY

Replace `YOUR_API_KEY` with the API key you received during sign-up.

Now you can use this link to fetch data in your custom code.

Step 4: Understand the Response

When you make the request, the API will return data in JSON format. Here's a simplified example of what the response might look like:

[

{

"date": "2023-12-31",

"priceEarningsRatio": 25.5,

"debtToEquity": 1.2,

"currentRatio": 1.5,

"netProfitMargin": 22.3,

"returnOnAssets": 15.4,

"returnOnEquity": 18.7

},

...

]

Each object in the array represents financial ratios for a specific date. You can use these ratios to analyze the company's performance over time.

II. Here's how you can use FMP data with FMP Playground:

Step 1: Go to Financial Modeling Prep Playground

Extract financial ratios data in CSV, text or JSON formats and export data into Excel for example.

Step2: Open FMP Playground.

On the left side of the screen find the FINANCIAL STATEMENTS field, click on it and then click on the RATIOS field.

Step3: Input the stock ticker

In the Symbol field input the stock ticker, choose your desired Period and extract the data.

Step4: Export your findings

In the top right corner find the Export button, to export your findings in CSV, JSON or Text formats.

Analyze the Data

Once you have the data, you can calculate and compare the financial ratios. Here's how you might interpret some of the data:

- Price-Earnings Ratio (P/E). A P/E of 25.5 suggests that investors are willing to pay $25.50 for every $1 of earnings. Compare this with industry averages to see if the stock is over or undervalued.

- Debt-to-Equity Ratio. At 1.2, the company has $1.20 in debt for every $1 of equity. This indicates the level of financial leverage the company is using.

- Current Ratio. A current ratio of 1.5 means the company can cover its short-term liabilities 1.5 times with its short-term assets. Generally, a ratio above 1 is good.

- Net Profit Margin. A margin of 22.3% shows that the company keeps $22.30 from every $100 in sales after all expenses.

Putting It All Together

By combining your understanding of financial ratios with the data from the FMP API, you can perform a comprehensive analysis of a company. Here's a simple process to follow:

1. Gather Data. Use the FMP API to collect the latest financial ratios.

2. Calculate Ratios. If needed, calculate additional ratios based on the data provided.

3. Compare. Look at how the company's ratios compare to industry standards or competitors.

4. Trend Analysis. Examine how the ratios have changed over time to identify trends.

5. Make Decisions. Use your analysis to buy or sell shares.

Analyzing a company using financial ratios is a powerful method to understand its financial health and performance. The Financial Modeling Prep API makes it easy to access the data you need without manually digging through financial statements. By following the steps outlined in this article, you can start analyzing companies effectively and make more informed financial decisions.