The ratios used in financial analysis are important for the following reasons.

1) Depending on the ratio used, it can assess whether the company is over borrowed
(gearing/leverage), whether it has enough cash to meet its short term obligations (liquidity/quick),
etc etc.
2) A financial analyst will "rip apart" the results of the company both on an annual, semi annual
and quarterly basis to make sure that the company is on track.
3) Time Trends -The analyst does not look at the ratios in isolation, rather he looks at the ratios
over a period of time to compare how the company is performing- he will seek explanation from
the company directors if there are serious blips or downward/adverse trends.
4) Industry Trends- The anlayst will then compare the ratios of those companies most closely
linked to see how each company is performing in relation to the other. This is why analysts tend
to specialise in one or maybe two sectors only. They need to have a handle on what is happening
in the industry sector as a whole, competition threats, currency problems etc etc.
5) Industry types - as a bald example, there are certain ranges of ratios which are considered
normal in one industry and abnormal in others. As a bald example, take the financials of a heavy
manufacturing company and it is common to see large investments in fixed assets and short term
borrowing and short term assets fairly closely matched, with gearing fairly low(hopefully!) But in a
trading company it would be completely different. Here you would expect to see very little
investment in fixed assets but gearing is usually very high and this is acceptable so long as short
term assets match. The reason for this is that a trading company will borrow short term, buy the
commodity (e.g. precious metals) and will sell on (trade) very quickly, thereby making a profit.

There are broadly 3 parts of a company's annual accounts which are analysed- get any financial
report and you will see graphs etc depicting the company results-always with a comparison over
time. The first is the Balance Sheet (a snapshot of the company's position on a given day b)
the Profit and Loss Statement ( trading results for a time period e..g. 12 months) and the Cash
flow statement.
There are different ratios for each of these statements.
One of the first jobs people do when they go to work in the City is to learn financial analysis -
many go on to to make it a lifetime career.

The difference between real rate of interest and nominal rate of interest

Real interest

The real interest rate is the nominal interest rate minus the rate of inflation, and thus is the
interest rate adjusted for inflation. Real Interest Rate is the amount by which the nominal
interest rate is higher than the inflation rate. The real rate of interest is approximated by
taking the nominal interest rate and subtracting inflation. The real interest rate is the
growth rate of purchasing power derived from an investment. There is a preference for
“real” applications for savings such as consumption or real investment. Real interest rate
compensates for delayed consumption or giving up real investment opportunities. The
higher the desire for consumption or real investment opportunities the higher the real rate
of interest.

The real rate of interest is determined by the demand and supply for savings at a given
point in time. The real rate is the price needed to delay consumption of funds demanded
for real investment. Upward shifts to the right (increases) in demand for desired real
investment cause the real rate of interest to increase. If the supply of desired savings
shifts upward (increases) to the right, the real rate of interest declines. The concept of real
rate of interest is a most important theoretical construct in monetary policy. Monetary
authorities use it as an instrumental measure to target the mandated or desired inflation
rate. (Brahmananda, 2001)

Nominal interest

Nominal interest is the rate of interest specified in loan contracts, without adjustment for
inflation. The annual return form lending money expressed as a percentage, without
having taken account of the rate of inflation. Nominal means “in name only”, this is
sometimes called the quoted rate. (McCracken, 2004) Normal Interest Rate is the stated
rate of interest applied to certain investment process.

Nominal Rate of Interest only has an impact on firms’ investment decisions if they are
accompanied by a change in the real interest rate. Research findings said that, empirical
investigations of the relationship between investment and demand uncertainty seldom use
appropriate empirical proxies that are close to the concept of demand uncertainty for
which the theory is developed. Results show that demand uncertainty reduces both
planned investment and realized investment (1991) for imperfectly competitive firms.
There was no evidence of an effect of price uncertainty on investment, which is
consistent with the assumption of price setting firms. Outcome show that demand
uncertainty reduces the level of investment plans, and do so by a non-negligible amount.
Butzen et al (2003), Guiso and Parigi (1999) and Patillo (1998) also report a negative
effect of demand uncertainty on firms’ investment.

Finally, such results suggest that, on average, firms adjust their investment plans very
little, although revisions may be substantial for some firms and years. Firms do not
modify their investment decisions due to the fact that part of the uncertainty had
disappeared between the time the investment was planned and the time investment is
realized. This contrasts with the effect of uncertainty on the timing of investment, as
stressed by the real-option theory. However, firms may revise their investment plans
according to new information on their fundamentals. In particular firms may adjust their
investment plans when observing sales growth, but they do so only slightly.

In summary, results indicate that the level of uncertainty affects investment plans, but
that plans are not revised as a result of a change in uncertainty. This suggests that a
reduction in the level of uncertainty would indeed enhance investment, but will do so
with a lagged effect, since uncertainty affects investment plans but not revisions of
current investment.
Definitions and Basics

Definition: The nominal value of a good is its value in terms of money.

Thereal value is its value in terms of some other good, service, or bundle of
goods.

Examples:

o Nominal: That CD costs $18. Japan's science and technology spending

is about 3 trillion yen per year.

o Real: A year of college costs about the value of a Toyota Camry. Those

tickets to see Van Halen cost me three weeks' worth of food!

Relative price is another term for the real price of a good or service. When
we say that the relative price of computers has fallen in recent years, we
mean that the price of computers relative to or measured in terms of other
goods and services—such as TVs or cars—has declined. Relative prices of
individual goods and services can decrease even if nominal prices are all
increasing, because of inflation.
Real versus nominal value, at Answers.com
In economics, the nominal values of something are its money values in
different years. Real values adjust for differences in the price level in those
years. Examples include a bundle of commodities, such as Gross Domestic
Product, and income. For a series of nominal values in successive years,
different values could be because of differences in the price level. But nominal
values do not specify how much of the difference is from changes in the price
level. Real values remove this ambiguity. Real values convert the nominal
values as if prices were constant in each year of the series. Any differences in
real values are then attributed to differences in quantities of the bundle or
differences in the amount of goods that the money incomes could buy in each
year....
Gross Domestic Product, from the Concise Encyclopedia of Economics
In practice BEA first uses the raw data on production to make estimates
of nominal GDP, or GDP in current dollars. It then adjusts these data for
inflation to arrive at real GDP. But BEA also uses the nominal GDP figures to
produce the "income side" of GDP in double-entry bookkeeping. For every
dollar of GDP there is a dollar of income. The income numbers inform us
about overall trends in the income of corporations and individuals. Other
agencies and private sources report bits and pieces of the income data, but
the income data associated with the GDP provide a comprehensive and
consistent set of income figures for the United States. These data can be used
to address important and controversial issues such as the level and growth of
 disposable income per capita, the return on investment, and the level of
saving....
Interest, from the Concise Encyclopedia of Economics
The real interest rate on money loans will be the stated (or nominal) rate
minus the anticipated rate of inflation. In countries that are experiencing
rapid growth in the amount of money available, interest rates will be very
high. But these will be not be high real interest rates. Instead, they will be
high nominal interest rates. If expected inflation is 10 percent, for example,
and if the real interest rate is 5 percent, the nominal interest rate is 15
percent. But someone who lends money at 15 percent for a year will not be
repaid with 15 percent more resources at the end of the year. Rather, the
lender will be repaid with 15 percent more money and will be able to use that
money to buy only 5 percent more resources. ...

In the News and Examples

Tax Freedom Day:

o Tax Freedom Day to Arrive April 23 in 2008. TaxFoundation.org

America Will Work Three Days Less to Pay Taxes in 2008 than in 2007;
Stimulus Rebates Push Date of Celebration Up.

o Tax Freedom Day (U.K., U.S., and other developed countries, at

AdamSmith.org

... just how much time do you spend working for the government?
How long does it take to work off the burden of taxation?

A Little History: Primary Sources and References

Irving Fisher, from the Concise Encyclopedia of Economics

Fisher was also the first economist to distinguish clearly between real and
nominal interest rates. He pointed out that the real interest rate is equal to
the nominal interest rate (the one we observe) minus the expected inflation
rate. If the nominal interest rate is 12 percent, for example, but people
expect inflation of 7 percent, then the real interest rate is only 5 percent.
Again, this is still the basic understanding of modern economists....

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