IMPORTANT RATIOS TO ANALYZE THE MINING SECTOR
The mining industry is one of the oldest yet established sectors in the world today. Mining has been crucial to the development of several nations, including Australia, Canada, Russia, and the United States. In America alone, both North and South America are rich in various mining deposits. The US was once considered the leading producer of certain major mining products, but stricter environmental regulations have curbed the industry’s presence.
Let’s have a quick refresher on the mining industry. The sector is subdivided into categories according to its primary mining interest. It has three main subdivisions: industrial and base metal mining, precious metals and gemstones mining, and nonmetal mining. BHP Billiton Limited and Rio Tinto Group are some of the major companies in the industry.
The sector requires deep capital expenditures for exploration and setting up mining operations. However, the operating costs of a mine tend to be significantly lower and almost stable once it becomes operational. Mining revenues fluctuate due to volatility in commodity prices; hence, it is vital to oversee changes in production levels wisely.
When gauging a company’s liquidity and overall financial health, analysts and investors use the quick ratio. The ratio basically measures a firm’s capability to manage its short-term obligations with its most liquid assets. It is determined by dividing the sum of current assets, and then deducting inventory by a corporation’s total short-term obligations. For evaluating mining companies, the so-called acid test ratio reveals the substantial capital expenditures and financing needed for mining operations. The minimum acceptable value is quick ratio values greater than 1.
There are other two financial margins to look at in analyzing the mining industry: operating profit margin and return on equity.
Operating Profit Margin
Analysts examine the operating profit margin to measure a company's effectivity in managing expenditures. The ratio is important as mining firms often adjust to production levels. It is calculated by dividing total revenues by total company expenses, excluding taxes and interest. This ratio is a strong indicator of its prospective growth and revenue. This is best used in comparing very similar companies.
Return on Equity
ROE indicates the level of profit a company can generate from equity and return to shareholders. In the mining sector, the average ROEs range between 5% and 9%. Corporations that perform best record ROEs of 15% or higher. Return on equity is computed by dividing net income by stockholders’ equity. The return on assets ratio or ROA is an alternative to this ratio.
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