Verification of Financial Models Using Ratio Analysis
When building a financial model to assess an organization’s intrinsic value and making future forecasts, it is crucial to verify the model using ratio analysis. If any of these ratios are significantly out of line with general statistics, it indicates that there might be an error either in the model or in the forecasts.
Below is a list of key ratios typically used for model verification:
- Price-to-Earnings (P/E) Ratio
- Price-to-Sales (P/S) Ratio
- Return on Equity (ROE)
- Return on Invested Capital (ROIC)
- Debt-to-Equity (D/E) Ratio
- Earnings Before Interest and Taxes (EBIT) Margin
- Net Profit Margin
- Gross Margin
- Current Ratio
- Quick Ratio
Ensuring these ratios are within reasonable ranges helps confirm the accuracy and reliability of the financial model and the projections it generates.
Source:
Corporate Valuation Theory, Evidence and Practice – by M. E. Zmijewski; R. W. Holthausen
