Tech Companies: Key Metrics to Assess Performance
The tech sector is a category that performs research, development, and distribution of technology-based products and services. Tech companies are usually large and they often carry little to no inventory, not profitable, and may take time to make revenue.
Liquidity ratios are helpful in gauging the company’s ability to meet short-meet obligation. Because many tech companies do not make profit or even generate revenue, it is extremely important to assess how well a technology company can meet its short-term financial obligations. Here are some useful ratios:
The current ratio is calculated by dividing current assets by current liabilities. This ratio is the most common liquidity ratio for measuring a company’s ability to meet its short term obligation. The current ratio is also considered the least conservative of all liquidity ratios.
In the tech industry, it’s important to have high current ratio since the business normally needs to fund all its operations from current assets such as the cash given by the investors.
The cash ratio, which is considered to be the most conservative liquidity ratio, is calculated by getting the sum of cash and marketable securities of the company and dividing it by current liabilities. It’s also the hardest evaluator to use to find whether the company can meet its obligations.
On top of those, the cash ratio is also the most important liquidity ratio for a tech company because the company normally only has cash and no other current assets, like inventory, to meet current obligations.
Meanwhile, a tech company may have a large number of marketable securities via acquisitions and investments. Bear in mind that these securities should be included in the calculations.
Financial Leverage Ratios
On the other side, financial leverage ratios are metrics for long-term solvency of a company. These types of ratios take into consideration long-term debt and any equity investments, both of which highly affect technology companies.
Debt to Equity Ratio
This ratio is highly important for the assessment of tech companies because many large tech companies make large investments in other tech companies and take on investments and debt from other organizations to fund product development. This is calculated by dividing total debt by total equity.
The technology company usually goes through outside investments or by issuing debt to acquire another company or fund necessary research and development. As a stakeholder, you must look at this ratio and see if the debt ratio is too high. If the debt ratio is too high, the company might be insolvent before turning a profit and paying back the debt.
Even though most companies are not profitable, it is necessary to look at what margins these companies; other ratios, such gross profit margin, are a good indicator of future profitability even if there is no current profit.
Gross Profit Margin
This profit margin gauges the gross profit earned on sales. It is only applicable if a technology company is generating revenue, but a high gross profit margin is a signal that once the company scales, it could become very profitable. A low gross profit margin is a sign that the company may not become profitable. Get the Wibest Broker Forex Education to help with Wibest Top Brokers.