Ratio Analysis Types

Definition of Ratio Analysis

Ratio analysis is a quantitative process that uses comparison ratios to determine the financial well-being of a business.
Using ratio analysis, we can learn more about a company’s liquidity, profitability, efficiency, and solvency by looking at
its essential financial measures.
It is basically like viewing a company’s report card. When you get your report card from school, you can see your
grades and determine how well you did in different subjects. Similarly, by looking at various ratios of a company, we
can see how well it is doing in different areas.
A ratio represents the relation between two or more financial metrics of a company by comparing the line items on
its financial statements. For instance, the debt-to-equity ratio describes the connection between the firm’s debt and
equity, which is available on its balance sheet. Learning ratio analysis types can simplify your understanding of how to
calculate and interpret various ratios.
This comprehensive article covers all the types and subtypes of ratio analysis using simple numerical examples and
real-world case studies of Apple, Amazon, Paypal, and Walt Disney.

Types of Ratio Analysis

We will discuss the 5 main categories of ratios along with their 24 subtypes below. We have also created an Excel
template with a detailed calculator for all the ratios. You can use the following template to practice anytime you want.
You can download this Ratio Analysis Types Template here – Ratio Analysis Types Template
1. Liquidity Ratios
Liquidity ratios can help you measure a company’s ability to handle its short-term debt obligations. A higher ratio
percentage means that the company is highly rich in cash.
The types of liquidity ratios are:
A) Current Ratio
It evaluates the relationship between a company’s current assets and liabilities. It indicates the liquidity of an
organization in being able to meet its debt obligations in the upcoming twelve months. A good ratio should be
between 1.2 to 3.
Current Ratio = Current Assets / Current Liabilities

Example & Interpretation:

Let’s find the current ratio for 2021 and 2022 and interpret the ratio’s values. Starlane Ltd. has the following financial
data for 2021 and 2022:

2021 2022

Current Assets = $570,000 Current Assets = $700,0000

Current Liabilities = $700,000 Current Liabilities = $530,000

Current ratio in 2021 = $570,000 / $700,000 = 0.81

Current ratio in 2022 = $700,000 / 530,000 = 1.32
1. High Current Ratio
Starlane Ltd. had a ratio of 1.32 in 2022, which is higher than 1.2, indicating that the company is highly capable of
repaying its short-term debt obligations.
2. Low Current Ratio
As Starlane Ltd. had a ratio of 0.81 in 2021, which is lower than 1.2, it may have difficulty repaying its short-term debt
obligations.
Current Ratio of Apple
Let us determine the current ratio of Apple Inc for 2022. We get the following financials from Apple’s annual report.
Current Ratio = Current Assets / Current Liabilities
= $135,405 / $153,982 = 0.88 With a ratio of 0.88, Apple had lower liquidity in 2022, meaning it may not have been
able to pay its short-term debt using liquid assets. However, companies do use other sources to repay their liabilities.
Thus, it does not mean that Apple has poor debt management.
Disclaimer: This financial ratio analysis of real companies is for educational purposes only, and EDUCBA does not intend to provide any specific
recommendations to investors for buying or selling stocks.

B) Quick Ratio
This ratio helps businesses ascertain information about the capability of a company to pay off its current liabilities on
an immediate basis. A company has a good ratio when the value is above 1.
Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities

OR
Quick Ratio = (Current Assets – Inventories) / Current Liabilities
Example & Interpretation:
Calculate and interpret the quick ratio for Marks & Co. using the following financial data for 2021 and 2022:

2021 2022

Current Assets = $250,000 Cash and Cash Equivalents = 39,000

Inventories = 20,000 Marketable Securities = 34,000

Current Liabilities = $200,000 Accounts Receivables = 26,000

Current Liabilities = $140,000

Quick ratio in 2021 = (Current Assets – Inventories) / Current Liabilities

= ($250,000 – $20,000 )/ $200,000 = 1.15
Quick ratio in 2022 = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities
= ($39,000 + $34,000 + $26,000) / $140,000 = 0.7
1. High Quick Ratio
As Marks & Co. had a higher ratio than 1 (1.15) in 2021, it had enough liquid assets to fulfill its debt obligations.
2. Low Quick Ratio
Marks & Co. had a lower ratio than 1 (0.7) in 2022, indicating the company had insufficient quick assets to repay its
debt in that financial year.
Quick Ratio of Amazon
Let us determine the quick ratio of Amazon Inc for 2021. We get the following financials from Amazon’s annual report.
Quick Ratio = (Current Assets – Inventories) / Current Liabilities= ($161,580 – 32,640) / $142,266 = 0.9Amazon Inc had
a quick ratio of 0.91 in 2021, indicating that it has slightly lower liquidity and, thus, relatively lower chances of repaying
debts using quick assets. However, it can use other assets or sources to fulfill its debt obligations.
C) Cash Ratio
It determines if the company can repay its short-term debt using cash, cash equivalents, or marketable securities. A
ratio of 0.5 or above is good.
Cash Ratio = Cash + Cash Equivalents / Total current liabilities

Example & Interpretation:

Compute the cash ratio for both years and interpret the results using the following data for Step-up Ltd.

2021 2022

Cash + Cash Equivalents = $67,000 Cash + Cash Equivalents = $49,000

Current Liabilities = $130,000 Current Liabilities = $150,000

Cash ratio in 2021 = $67,000 / $130,000 = 0.51

Cash ratio in 2022 = $49,000 / $150,000 = 0.33
1. High Cash Ratio
As Step-up Ltd. had a higher ratio than 0.5 in 2021, it could repay at least 0.51, i.e., 51% of its liabilities using cash and
cash equivalents. However, it also means the company had a poor capital management system.
2. Low Cash Ratio
Step-up Ltd. had a lower ratio than 0.5 (0.33) in 2022, signifying that the company had inadequate liquid cash to fulfill
its total debt obligations. However, it also indicates that the company had better capital management.
Cash Ratio of Paypal Holdings
Let us determine the cash ratio of Paypal Holdings for 2021. We get the following financials from Paypal’s annual
report.
Cash Ratio = Cash + Cash equivalents / Current Liabilities
= $5,197 / $43,029 = 0.12
Paypal Holdings’ cash ratio of 0.12 (less than 0.5) signifies that if the company uses all of its cash and cash equivalents,
it can pay 12% of its total short-term debt using only cash and cash equivalents.
D) Operating Cash Flow Ratio
It calculates how often a company can pay its debt using the cash it generates in a single period. A ratio of 1 or
above is favorable for businesses.
Operating Cash Flow = Cash from operations / Total current liabilities

Example & Interpretation:

Let us calculate Amplework Ltd’s operating cash flow ratio and analyze it. Here is the company’s financial data:
 2021 2022

Cash from operations = $33,000 Cash from operations = $56,000

Current Liabilities = $100,000 Current Liabilities = $49,000

Operating Cash Flow ratio in 2021 = $33,000 / $100,000 = 0.34

Operating Cash Flow ratio in 2022 = $56,000 / $49,000 = 1.14
1. High Operating Cash Flow Ratio
As Amplework Ltd. had a ratio of 1.14 (higher than 1) in 2022, it could quickly fulfill its debt obligations using its cash
flow from operations.
2. Low Operating Cash Flow Ratio
As Amplework Ltd. had a ratio of 0.34 (lower than 1) in 2021, its cash flow from operations cannot cover its liabilities.
The company must generate extra income from financing and investing activities to fulfill debt obligations.
Operating Cash Flow Ratio of Walt Disney Co.
Let us determine the operating cash flow ratio of Walt Disney Co for 2022. We get the following financials from its
consolidated balance sheet and cash flow statement from the annual report.

Operating Cash Flow Ratio = Cash from operations / Total current liabilities
= $6,002 / $29,073 = 0.21 .An operating cash flow ratio of 0.21 is less than 1, indicating that Walt Disney is generating
less cash (20%) than it must generate to pay all its liabilities. Nonetheless, the firm can utilize money from non-
operating sources to pay the debts in such cases.

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2. Profitability Ratios
This ratio helps measure a company’s ability to earn sufficient profits.
The types of profitability ratios are:
A) Gross Profit Margin Ratio
It represents the operating profits of an organization after making necessary adjustments to the COGS or cost of goods
sold. It helps firms ascertain their efficiency in converting finished goods and incurred labor into profit. A good ratio
should be 20% or higher.
Gross Profit Margin Ratio = (Gross Profit / Net Sales) * 100

Example & Interpretation:

Determine the gross profit ratio for South & West Ltd. and interpret the ratio. Below are the financials of the
company:

2021 2022
 Gross Profit = $120,000 Gross Profit = $170,000

Net Sales = $750,000 Net Sales = $590,000

Gross Profit Ratio in 2021 = ($120,000 / $750,000) * 100 = 16%

Gross Profit Ratio in 2022 = ($170,000 / $590,000) * 100 = 28.8%
1. High Gross Profit Margin Ratio
As South & West Ltd. had a higher ratio than 20% in 2022, it indicates good profitability and generated 28.8% income
on 100% of its sales.
2. Low Gross Profit Margin Ratio
South & West Ltd. had a lower ratio than 20% in 2021, indicating lower profitability. It generated only 16% in profit on
its total sales.
Gross Profit Margin Ratio of Apple Inc.
Let us determine the gross profit ratio of Apple Inc for 2022. We get the following financials from Apple’s annual
report.

Gross Profit Ratio = (Gross Profit / Net Sales) * 100

= ($170,782 / $394,328) * 100 = 87.94%
Apple’s gross profit ratio of 87.94% indicates that the company is highly profitable and generates $80 as profit on each
product they sell for $100.
B) Net Profit Ratio
Net profit ratios determine the overall profitability of an organization after reducing both cash and non-cash
expenditures. An excellent net profit should be equal to or higher than 10%.
Net Profit Ratio = (Net Profit / Net Sales) * 100

Example & Interpretation:

Let us find the net profit ratio for Lorris & Co. and interpret its meaning. Find the details of the company below:

2021 2022

Net Profit = $30,000 Net Profit = $80,000

Net Sales = $550,000 Net Sales = $620,000

Net Profit Ratio in 2021 = ($30,000 / $550,000) * 100 = 5.45%

Net Profit Ratio in 2022 = ($80,000 / $620,000) * 100 = 12.9%
1. High Net Profit Ratio
Lorris & Co. had a higher ratio than 10% (12.9%) in 2022, meaning the firm made $12.9 on every $100 product it sold
after deducting all the costs and expenses. It is a considerably good value for the company.
2. Low Net Profit Ratio
Lorris & Co. had a lower ratio than 10% (5.45%) in 2021. So after deducting all costs, the company only makes $5.45
on each $100 product they sell. It is not a very profitable value for the business.
Net Profit Ratio of Amazon Inc.
Let us determine the net profit ratio of Amazon Inc for 2021. We get the following financials from Amazon’s annual
report.
Net Profit Ratio = (Net Profit / Net Sales) * 100
= ($11,588 / $280,522) * 100 = 4.13%
Amazon Inc. has a net profit ratio of 4.13% in 2021. It shows their profit margin is lower than the industry average of
5%. Thus, they can adjust and focus on their pricing strategy to improve their profitability.
C) Operating Profit Ratio
It can help us ascertain the organization’s profits and financial ability to repay all short-term and long-term debt
obligations. A good ratio should be 10% or above.
Operating Profit Ratio = (Earnings Before Interest and Taxes (EBIT) / Net Sales) * 100

Example & Interpretation:

Let us determine the operating profit ratio for Globex Corp. and interpret its resulting ratio. Below is the table with the
company’s financial information for 2021 and 2022.

2021 2022

EBIT = $25,000 EBIT = $13,000

 Net Sales = $135,000 Net Sales = $150,000

Operating Profit Ratio in 2021 = ($25,000 / $135,000) * 100 = 18.5%

Operating Profit Ratio in 2022 = ($13,000 / $150,000) * 100 = 8.67%
1. High Operating Profit Ratio
Globex Corp. had a higher ratio than 10% in 2021, indicating higher profitability and 18.5% of its total revenue is its
operating profit.
2. Low Operating Profit Ratio
As Globex Corp. had a lower ratio than 20% in 2022, it means that it had lower profitability, and only 8.67% of its
revenue was operating profit.
D) Return on Capital Employed (ROCE)
It determines an organization’s profitability concerning the capital invested in the business. A business with a 20% or
more ratio value is profitable.
ROCE = (Earnings Before Interest and Taxes (EBIT) / Capital Employed) * 100

Example & Interpretation:

Let us calculate the ROCE of Nesham Ltd. for 2021 and 2022 and interpret the results. Below are the financials of the
company:

2021 2022
 EBIT = $15,000 EBIT = $25,000

Capital Employed = $125,000 Capital Employed = $115,000

Return on Capital Employed Ratio in 2021 = ($15,000 / $125,000) * 100 = 12%

Return on Capital Employed Ratio in 2022 = ($25,000 / $115,000) * 100 = 21.7%
1. High Return on Capital Employed Ratio
As Nesham Ltd. had a higher ratio than 20% in 2022, the 21.7% ratio signifies that it uses its employed capital
effectively to generate enough profits.
2. Low Return on Capital Employed Ratio
As Nesham Ltd. had a lower ratio than 20% in 2021, the 12% ratio signifies that it cannot generate enough profits
from its employed business capital.
E) Return on Assets (ROA)
It calculates the efficiency of a business employing its total assets to generate profits. A good ROA ratio to have is 5%
and higher.
Return on Assets = (Net Income / Total Assets) * 100

Example & Interpretation:

Calculate Asten & Co’s return on assets ratio and interpret the results of the ratio. Below is a table with Asten & Co’s
financial data for 2021 and 2022:
 2021 2022

Net Income = $12,000 Net Income = $17,000

Total Assets = $300,000 Total Assets = $320,000

Return on Assets Ratio in 2021 = ($12,000 / $300,000) * 100 = 4%

Return on Assets Ratio in 2022 = ($17,000 / $320,000) * 100 = 5.3%
1. High Return on Assets Ratio
Asten & Co. had a higher ratio than 5% (5.3%) in 2022, indicating that the business had reliable asset management
and was generating good profits with smaller investments.
2. Low Return on Assets Ratio
Asten & Co. had a lower ratio than 5% (4%) in 2021, signifying that the company could not generate enough profits
from current asset investments and thus had poor asset management.
F) Return on Equity (ROE)
It determines how well a company uses its shareholders’ capital to generate profits. While a ratio of 15% to 20% is
good, the higher the ratio, the better.
Return on Equity = (Net Income / Shareholders Equity) * 100

Example & Interpretation:

Let us interpret the profitability of Lorens Lane Ltd. by calculating its return on equity ratio. The company’s data for
2021 and 2022 are given in the table below:
 2021 2022

Net Income = $20,000 Net Income = $12,000

Shareholders Equity = $100,000 Shareholders Equity = $140,000

Return on Equity Ratio in 2021 = ($20,000 / $100,000) * 100 = 20%

Return on Equity Ratio in 2022 = ($12,000 / $140,000) * 100 = 8.5%
1. High Return on Equity Ratio
As Lorens Lane Ltd. had a ratio higher than 15% in 2021, it indicates that the business could generate a good level of
profit (20%) using its shareholder’s invested capital.
2. Low Return on Equity Ratio
As Lorens Lane Ltd. had a ratio lower than 15% in 2022, the company did not use the shareholder’s invested money
effectively. It thus generated lower profits (8.5%).

3. Solvency Ratios
Solvency ratio is a type of ratio that evaluates whether a company is solvent and well capable of paying off its debt
obligations or not.
The types of solvency ratios are:
A) Debt-Equity Ratio
The debt-equity ratio is the ratio between total debt and shareholders’ funds. It calculates the leverage of an
organization. An ideal ratio for an organization is 2:1.
Debt Equity Ratio = Total Liabilities / Shareholders Equity

Example & Interpretation:

Compute the debt-equity ratio for Ramp-up Ltd. using the given data for 2021 and 2022 and interpret the resulting
ratios.

2021 2022

Total Liabilities = $250,000 Total Liabilities = $150,000

Shareholders Equity = $90,000 Shareholders Equity = $80,000

Debt-Equity ratio in 2021 = $250,000 / $90,000 = 2.7

Debt-Equity ratio in 2022 = $150,000 / $80,000 = 1.87
1. High Debt-Equity Ratio
As Ramp-up Ltd. had a ratio of 2.7 in 2021, which is higher than 2, it was using more debt (borrowings from the
market) than equity to run its business operations, which can be risky, as per investors.
2. Low Debt-Equity Ratio
As Ramp-up Ltd. had a ratio of 1.87 in 2022, which was lower than 2, it started using less debt for funding its business
and is less risky. However, the ratio should not fall below 1, as it can mean the firm has higher liabilities which is not a
good sign.
Debt-Equity Ratio of Paypal Holdings
Let us determine the Debt-Equity ratio of Paypal Holdings for 2021. We can find the financial data from Paypal’s annual
report.

Debt-Equity Ratio = Total Liabilities / Shareholders Equity

= $54,076 / $21,727 = 2.49
Paypal Holdings’ debt-to-equity ratio is 2.49, which is higher than the average ratio of 2:1. It indicates that the
company uses more debt than equity to fund its operations.

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B) Debt to Assets
It computes how much debt a company uses to fund its assets and business. An ideal Debt to Asset ratio is a
ratio lower than 1.
Debt to Assets = Total Debt / Total Assets

Example & Interpretation:

Determine the debt-to-assets ratio for Holy & Poly Ltd. and analyze it. Following is the company’s financial data for
2021 and 2022:
 2021 2022

Total Debt = $168,000 Total Debt = $125,000

Total Assets = $130,000 Total Assets = $180,000

Debt to Assets ratio in 2021 = $168,000 / $130,000 = 1.29

Debt to Assets ratio in 2022 = $125,000 / $180,000 = 0.69
1. High Debt to Assets Ratio
Holy & Poly Ltd. had a higher ratio than 1 (1.29) in 2021, indicating that the company has been using more debt to
finance its assets, making it a riskier investment for investors.
2. Low Debt to Assets Ratio
Holy & Poly Ltd. had a lower ratio than 1 (0.69) in 2022, indicating that the company uses lesser debt to fund its
assets, making it a favorable option for investors.
Debt to Assets Ratio of Walt Disney Co.
Let us determine the debt-to-assets ratio of Walt Disney Co for 2022. We find its financials from Walt Disney’s annual
report.
Debt to Assets Ratio = Total Debt / Total Assets
= ($3,070 + $45,299) / $203,631 = 48,369 / 203,631
= 0.24
Walt Disney had a debt-to-assets ratio of 0.24 in 2022. Less than 1 indicates that the company has a higher leverage
and uses only 24% of its debt to fund its assets. Thus, it maintains an excellent financial position.
C) Debt Service Coverage Ratio (DSCR)
It determines if the firm can generate enough cash flow in an accounting period to fulfill its debt obligations, including
interests and principles. A good DSCR ratio is a value of 1.2 or higher.
Debt Service Coverage Ratio = Net Operating Income / Debt Service

Example & Interpretation:

Let us calculate the debt service coverage ratio of Parks In Ltd. for 2021 and 2022 and analyze the ratio. Their financial
information is in the table below:

2021 2022

Net Operating Income = $100,000 Net Operating Income = $130,000

Debt Service = $92,000 Debt Service = $80,000

Debt Service Coverage ratio in 2021 = $100,000 / $92,000 = 1.08

Debt Service Coverage ratio in 2022 = $130,000 / $80,000 = 1.62
1. High Debt Service Coverage Ratio
Parks In Ltd. had a ratio higher than 1.2 (1.62) in 2022, which signifies that the business had enough cash flow to fulfill
its debt obligations and did not need borrowings to cover its liabilities.
2. Low Debt Service Coverage Ratio
Parks In Ltd. had a ratio lower than 1.2 (1.08) in 2021, signifying it lacks enough cash flow. Thus, the company may
need to borrow money from outside sources to cover all of its pending debt.
D) Interest Coverage Ratio
The interest coverage ratio determines the solvency of an organization in the short-term future. It calculates the
number of times an organization’s profits can cover its interest-related expenses. A good interest coverage ratio should
be 1.5 or above.
Interest Coverage Ratio = Earnings Before Interest and Taxes (EBITDA) / Interest Expense

Example & Interpretation:

Compute the interest coverage ratio of Wendy & Co. for 2021 and 2022. Also, analyze the results and interpret the
ratio. The company’s financial data is as follows:

2021 2022

EBITDA = $100,000 EBITDA = $140,000

Interest Expense = $85,000 Interest Expense = $85,000

Interest Coverage ratio in 2021 = $100,000 / $85,000 = 1.17

Interest Coverage ratio in 2022 = $140,000 / $85,000 = 1.64
1. High Interest Coverage Ratio
Wendy & Co. had a higher ratio than 1.5 in 2022. The percentage of 1.64 means the company could quickly pay
the interest expenses on its debts using its profits. Thus, the firm has higher solvency.
2. Low Interest Coverage Ratio
Wendy & Co. had a lower ratio than 1.5 in 2021. A ratio of 1.17 means that the firm had fewer profits and couldn’t
cover its interest, and stands a higher possibility of going bankrupt.

4. Turnover Ratios
Turnover ratios determine how efficiently an organization’s financial assets and liabilities have been used to
generate revenues.
The types of turnover ratios are:
A) Fixed Assets Turnover Ratio
It determines the efficiency of an organization in utilizing its fixed assets to generate revenues. An ideal ratio value
is 1.5 or more. However, it differs from industry to industry.
Fixed Assets Turnover Ratio = Net Sales / Average Fixed Assets

Example & Interpretation:

Find the fixed assets turnover ratio of Marshall Corp and interpret its results for 2021 and 2022. The financial
information of the company is in the table below:

2021 2022
 Net Sales = $300,000 Net Sales = $375,000

Average Fixed Assets = $225,000 Average Fixed Assets = $200,000

Fixed Assets Turnover Ratio in 2021 = ($300,000 / $225,000) = 1.33

Fixed Assets Turnover Ratio in 2022 = ($375,000 / $200,000) = 1.87
1. High Fixed Assets Turnover Ratio
In 2022, Marshall Corp had a ratio of 1.87, which is higher than 1.5, indicating that the company could generate
enough sales by utilizing its fixed assets (building, equipment, etc.).
2. Low Fixed Assets Turnover Ratio
In 2021, Marshall Corp had a ratio of 1.33, which is lower than 1.5, indicating that the firm couldn’t generate enough
sales by employing its fixed assets. Thus, it had poor asset management.
Fixed Assets Turnover Ratio of Apple Inc.
Let us determine the fixed assets turnover ratio of Apple Inc for 2022. We get the following financials from
Apple’s annual report.

Fixed Assets Turnover Ratio = Net Sales / Average Fixed Assets

= $394,328 / $42,117 = 9.36
Apple had a fixed assets turnover ratio of 9.36 in 2022, which is higher than the IT industry’s ideal fixed asset turnover
ratio. Thus, it signifies that the company has solid asset management and is generating substantially higher profits
using its fixed assets.
B) Inventory Turnover Ratio
The inventory turnover ratio determines a company’s speed in converting its inventories into sales. A company should
have an inventory turnover ratio of between 5 to 10.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventories
Example & Interpretation:
Let us find the inventory turnover ratio for Markwood Ltd. and interpret its meaning. Find the details of the company
below:

2021 2022

Cost of Goods Sold = $420,000 Cost of Goods Sold = $380,000

Average Inventories = $80,000 Average Inventories = $120,000

Inventory Turnover Ratio in 2021 = ($420,000 / $80,000) = 5.25

Inventory Turnover Ratio in 2022 = ($380,000 / $120,000) = 3.16
1. High Inventory Turnover Ratio
As Markwood Ltd. had a higher ratio than 5 (5.25) in 2021, the firm had a good sales turnover, and the product had a
high market demand.
2. Low Inventory Turnover Ratio
As Markwood Ltd. had a lower ratio than 5 (3.16) in 2022, the firm cannot convert its inventory into sales as much as
it should. It may also happen due to the product’s poor market demand.
Inventory Turnover Ratio of Amazon Inc.
Let us determine the inventory turnover ratio of Amazon Inc for 2021. We get the following financials from
Amazon’s annual report.Inventory Turnover Ratio = Cost of Goods Sold / Average Inventories
= $272,344 / (($23,795 + $32,640) / 2)
= $272,344 / 28,218 = 1.16
Amazon’s inventory turnover ratio of 1.16 in 2021 shows that the firm may have lower than usual efficiency in
converting inventory into sales. They can increase their ratio by cutting costs, reducing inventory volume, increasing
product demand, or pricing their products effectively.
C) Receivable Turnover Ratio
It calculates the average number of times a firm collects its account receivables to determine its efficiency. Typically, a
firm should collect its receivables at least once a year (ratio = 1).
Receivables Turnover Ratio = Net Credit Sales / Average Account Receivables

Example & Interpretation:

Calculate Cindylane Ltd’s receivable turnover ratio for 2021 and 2022 using the data given below:

2021 2022

Net Credit Sales = $92,000 Net Credit Sales = $230,000

 Average Account Receivables= $110,000 Average Account Receivables = $115,000

Receivable Turnover Ratio in 2021 = ($92,000 / $110,000) = 0.84

Receivable Turnover Ratio in 2022 = ($230,000 / $115,000) = 2
1. High Receivable Turnover Ratio
As Cindylane Ltd. had a ratio higher than 1 in 2022, the firm could collect all its receivables 2 times in one accounting
period.
2. Low Receivable Turnover Ratio
Cindylane Ltd. had a lower ratio than 1 in 2021. The firm had weak credit policies, poor credit collection techniques,
etc. It could not collect all its receivables even once in a financial year (ratio =0.84).
D) Working Capital Turnover Ratio
It effectively measures how efficiently a business uses its working capital to generate sales. A good working capital
ratio should fall between 1.5 to 2.5.
Working Capital Turnover Ratio = Turnover (Net Sales) / Working Capital

Example & Interpretation:

Let us find the working capital turnover ratio for 2020, 2021, and 2022 of company Driven & Co. We will also interpret
the results and describe what they mean. Details of the company are in the table below:

2020 2021 2022

Turnover = $290,000 Turnover = $450,000 Turnover = $330,000

 Working Capital = $280,000 Working Capital = $170,000 Working Capital = $180,000

Working Capital Turnover Ratio in 2020 = ($290,000 / $280,000) = 1.03

Working Capital Turnover Ratio in 2021 = ($450,000 / $170,000) = 2.64
Working Capital Turnover Ratio in 2022 = ($330,000 / $180,000) = 1.83
1. High Working Capital Turnover Ratio
As Driven & Co. had a higher ratio than 2.5 in 2021, the ratio of 2.64 indicates that the company uses most of its
working capital to generate sales. Thus, the company cannot use its current working capital to invest in future growth
projects.

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2. Low Working Capital Turnover Ratio

As Driven & Co. had a lower ratio than 1.5 in 2020, the ratio of 1.03 indicates that the firm is not generating sales
using its working capital and may even face liquidity issues in the short term.
3. Good Working Capital Turnover Ratio
As Driven & Co. had a ratio between 1.5 and 2.5 in 2022, the ratio of 1.83 indicates that the business is efficiently
using its working capital to generate sales and has enough to fund its future growth prospects.
E) Payables Turnover Ratio
It is a ratio that computes the number of times a business pays its accounts payables in a single accounting period. A
good value for this ratio falls between 6 to 10, or it can be higher too.
Payables Turnover Ratio = Purchases / Accounts Payable

Example & Interpretation:

Let us find the company Vennwood Corp’s payables turnover ratio and interpret its resulting ratios for 2021 and 2022.
The below table contains the details of the company:

2021 2022

Purchases = $450,000 Purchases = $570,000

Accounts Payable = $100,000 Accounts Payable = $80,000

Payables Turnover Ratio in 2021 = ($450,000 / $100,000) = 4.5

Payables Turnover Ratio in 2022 = ($570,000 / $80,000) = 7.125
1. High Payables Turnover Ratio
As Vennwood Corp had a higher ratio than 6 (7.125) in 2022, the firm was able to pay its dues and debts regularly,
creating a good relationship with suppliers and creditors.
2. Low Payables Turnover Ratio
As Vennwood Corp had a lower ratio than 6 (4.5) in 2021, the firm could not pay its short-term debts and credit
purchases due to inadequate cash flow or poor financial management.
F) Cash Conversion Cycle Ratio
This ratio calculates the total days a business takes to earn back the cash it spent on inventory by selling its products.
The benchmark for this ratio is 30-45 days.
Cash Conversion Cycle Ratio = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)

Example & Interpretation:

Compute the cash conversion cycle ratio of Jim & Jorge Ltd. for 2021 and 2022. Also, interpret the resulting ratios. The
details for the company’s financials are in the table below:

2021 2022

Days Inventory Outstanding (DIO) = 111.4 Days Inventory Outstanding (DIO) = 120

Days Sales Outstanding (DSO) = 8.6 Days Sales Outstanding (DSO) = 15

Days Payable Outstanding (DPO) = 50 Days Payable Outstanding (DPO) = 101

Cash Conversion Cycle Ratio in 2021 = 111.4 + 8.6 – 50 = 70

Cash Conversion Cycle Ratio in 2022 = 120 + 15 – 101 = 34
1. High Cash Conversion Cycle Ratio
As Jim & Jorge Ltd. had a higher ratio than 45 days in 2021, it indicates that it took the firm 70 days to earn the
amount of money it spent on making an inventory. Thus, it has lesser control over its working capital.
2. Low Cash Conversion Cycle Ratio
As Jim & Jorge Ltd. had a lower ratio than 45 days in 2022, it indicates that it could efficiently convert its inventory into
sales and collect the equivalent or more of what it spent on the inventory in 34 days. It gives the company better
liquidity and adequate working capital for its business.

5. Earnings Ratios
Earnings ratios determine the returns that an organization generates for its investors.
The types of earnings ratios are:
A) Profit/Earnings Ratio
The P/E ratio helps determine if a stock’s value is underpriced or overpriced by calculating the price of its share as per
its earnings per share. Ideally, a good P/E ratio should be below 20.
Profit/Earnings Ratio = Market Price per Share / Earnings per Share
Example & Interpretation:
Using the data, compute the profit-to-earnings ratio of RisenMark Ltd. for 2021 and 2022. Also, compare and interpret
the resulting ratios.

2021 2022

Market Price per Share = $60 Market Price per Share = $50

Earnings per Share = 2.4 Earnings per Share = 2.63

Profit/Earnings ratio in 2021 = $250,000 / 90,000 = 25
Profit/Earnings ratio in 2022 = $150,000 / 80,000 = 19
1. High Profit/Earnings Ratio
As RisenMark Ltd. had a higher ratio than 20 (25) in 2021, each share is overpriced compared to what the company is
earning for a single share. It makes the share risky for investors.
2. Low Profit/Earnings Ratio
As RisenMark Ltd. had a lower ratio than 20 (19) in 2022, it means that compared to the profit the company makes on
each share, the share’s pricing is accurate or maybe underpriced. It indicates that there are chances that the prices will
increase, making it a good investment opportunity.
Profit/Earnings Ratio of Paypal Holdings
Let us determine the profits/earnings ratio of Paypal Holdings for 2021. We can find the financial data from
Paypal’s annual report.
Profit/Earnings Ratio = Market Price per Share / Earnings per Share
= 188.58 / 3.52 = 53.57
Paypal Holdings’ had a profit-to-earning ratio of 53.57 in 2021. It shows that the share was overpriced, and the
investors and shareholders paid higher value. On the other hand, it can also signify that the Paypal stock has future
growth potential. Thus, before making any decisions, investors must use other tools like financial analysis, financial
modeling, and valuation to arrive at a possible conclusion.
B) Earnings per Share (EPS)
Earnings per share (EPS) computes the value a company generates for each shareholder. There is no ideal ratio for EPS.
The higher the ratio, the better. However, we can compare the current ratio value with the previous year to
determine if it is doing well.
EPS = (Net Income – Preferred Dividends) / (Weighted Average of Outstanding Shares)

Example & Interpretation:

Determine the EPS ratio for Lorris & Marks Ltd. and analyze its resulting ratios. Following is the company’s financial
information for 2021 and 2022:

2021 2022

Net Income = $248,000 Net Income = $100,000

Preferred Dividends = 0 Preferred Dividends = 0

Weighted Average of Outstanding Shares = Weighted Average of Outstanding Shares =

100,000 110,000

EPS ratio in 2021 = ($248,000 – 0 ) / $100,000 = 2.48

EPS ratio in 2022 = ($100,000 – 0 ) / $110,000 = 0.9
1. High EPS Ratio
Lorris & Marks Ltd. had a higher ratio than 1 in 2021, indicating that the company is generating higher returns on each
of its shares which is good for existing shareholders and new investors. It means that for each $1 that investors invest
in this company’s shares, they get a return of $2.48.
2. Low EPS Ratio
Lorris & Marks Ltd. had a lower ratio than 1 in 2022, indicating that the firm could not generate higher profits on its
shares. The lower the EPS, the less likely investors are to purchase the stock. It means that for every $1 investor invests
in this company’s stocks, they only get $0.9 in return.
EPS Ratio of Walt Disney Co.
Let us determine the EPS ratio of Walt Disney Co for 2022. We find its financials from Walt Disney’s annual report.

EPS = (Net Income – Preferred Dividends) / (Weighted Average of Outstanding Shares)

= ($3,145 – 0) / 1827 = $1.72
Walt Disney’s EPS for 2022 was $1.72, i.e., it earned $1.72 on every share the company had. Compared to the
company’s previous year’s EPS of $1.09, it is an increase and thus a good sign for investors.
C) Dividend Yield Ratio
It determines the return an investor or shareholders receives as dividends compared to how much they have invested
in the company’s shares. A good dividend yield ratio should be 2% or higher.
Dividend Yield = (Dividend Per Share / Share Price) * 100

Example & Interpretation:

Compute the dividend yield ratio of Osten Company using the details below and interpret the resulting ratios for 2021
and 2022.

2021 2022

Dividend Per Share = $4.83 Dividend Per Share = $1.98

Share Price = $105 Share Price = $110

Dividend Yield Ratio in 2021 = ($4.83 / $105) * 100 = 4.6%

Dividend Yield Ratio in 2022 = ($1.98 / $110) * 100 = 1.8%
1. High Dividend Yield Ratio
Osten Company had a higher ratio than 2% in 2021, signifying that the company pays 4.6% of the share price back to
the investors as dividends. It makes the stock desirable.
2. Low Dividend Yield Ratio
Osten Company had a lower ratio than 2% in 2022, signifying that the firm is paying them 1.8% of the shareholders’
investments as dividends. It might make the stock undesirable.
D) Dividend Payout Ratio
It calculates the total percentage of income a company uses to pay dividends to its shareholders. An ideal payout ratio
for companies is 30% to 50% or lower.
Dividend Payout = (Total Dividends / Net Income) * 100

Example & Interpretation:

Compute the dividend payout ratio for Karls & Webber for the year 2021 and 2022. Also, interpret the resulting ratios.
The details for the company’s financials are in the table below:

2021 2022

Total Dividends = $225,000 Total Dividends = $150,000

Net Income = $370,000 Net Income = $420,000

Dividend Payout Ratio in 2021 = ($225,000 / $370,000) * 100 = 60.8%

Dividend Payout Ratio in 2022 = ($150,000 / $420,000) * 100 = 35.7%
1. High Dividend Payout Ratio
Karls & Webber had a higher ratio than 50% in 2021, meaning that the business is using more than half, 60.8% of its
profits, to distribute dividends to its shareholders. Although it may seem preferable, the company may not use most
earnings to reinvest in the business, which can restrict its growth.
2. Low Dividend Payout Ratio
Karls & Webber had a lower ratio than 50% in 2022, meaning it is using less than half, which is 35.7% of its earnings,
to repay investors through dividends and invest the rest back into the business. It can use the rest to invest in business
expansion plans or growth prospects.

Why is Ratio Analysis Important?

Now that we have understood how to calculate each ratio with the help of examples of real companies, we are in a
better position to understand their importance. Here are some reasons why ratio analysis is necessary:
Simplify Financial Aspects: It simplifies the financial information of a business and can help you quickly understand its
financial situation.
Financial Analysis: It makes it possible to assess the performance and health of a company by analyzing its financial
position.
Determine Risks: It helps determine any current or future business and financial risks so you can reduce risk and boost
the likelihood of success.
Utilization of Funds: Companies can analyze ratios to regulate their use of funds to improve their financial
performance.
Planning & Forecasting: Companies can make future projections and forecasts and use them to make plans of action
for their businesses.
Comparisons: It enables investors to compare a company’s financial performance to benchmarks set by the industry or
its competitors. Comparisons within the company are also possible.
Business Decision Making: It can help find trends and patterns to identify a company’s strengths or problems to make
knowledgeable choices about financing or investing. It also helps form opinions and make well-informed choices
on mergers and acquisitions, investment opportunities, and other business decisions.
Industry-Specific Ratios
Companies in different industries use different kinds of ratios to understand how their firm is performing. Here is a list
of common ratios that are useful in specific industries. We have also given examples and each ratio’s interpretation:

Industry Ratio Well-known Companies and Performance

Their Ratios (2022)

Technology Price-to-Earnings Apple – 22.03 Good

Ratio (P/E Ratio)

Return on Equity Microsoft – 39.32% Excellent

Quick Ratio Alphabet (Google) – 2.2 Good

Retail Gross Profit Margin Walmart – 23.5% Excellent

Inventory Turnover Amazon – 8.01 Good

Return on Assets Target – 5.2% Good

Debt-to-Equity Ratio Costco – 1.67 Good

Automobile Inventory Turnover BMW – 6.69 Good

Return on Ford – (-1.63%) Poor

Investment

Debt-to-Equity Ratio Toyota – 1.03 Excellent

Gross Profit Margin Tesla – 28.5% Excellent

Manufacturing Asset Turnover General Electric – 0.3 Poor

Return on Caterpillar – 13.29% Excellent

Investment

Operating Margin Tesla – 12.47% Good

Healthcare Current Ratio Johnson & Johnson – 0.99 Average

Days in Accounts Pfizer – 50.77 Good

 Receivable

Interest Coverage UnitedHealth Group – 13.6 Excellent

Ratio

Limitations of Specific Ratios

Although ratio analysis is instrumental in a company’s evaluation, specific ratios may be less helpful for different
sectors and industries. In this section, we discuss the limitations of particular ratios and provide examples of when
they may not be as helpful.

Ratio Industries in Why? Alternate Ratios

which the ratio
may not be
useful

Quick Ratio Manufacturing They invest heavily in fixed Current Ratio,

& Construction assets, like equipment,
Cash Ratio
machinery, and industrial
plants.

Consulting or They have quick assets like Quick assets like accounts
 Software accounts receivable which receivable may have
Development may have varying collection varying collection periods,
periods. making it challenging to
estimate liquidity
accurately.

Operating Manufacturing, They invest their operating Debt-to-Equity Ratio,

Cash Flow Infrastructure, cash flow into long-term
Current Ratio
Ratio and assets like equipment and
Construction property instead of having
cash on hand.

Gross Profit Retail They have a range of pricing Operating Profit Ratio,
Ratio strategies like discounts and
Net Profit Ratio
promotions. So, they might
have lower profit margins,
even though they sell many
products.

Construction The cost of goods sold can

vary widely between
projects, affecting the
 accuracy of the ratio.

ROA Ratio Service-based They depend more on Return on Invested Capital

industries human capital and intangible (ROIC)
(consulting, assets (intellectual property
advertising, or brand value) than physical
software assets.
development)

ROE Ratio Technology or They rely heavily on Return on Capital Employed

Pharmaceuticals intangible assets as the ratio (ROCE),
only factors in the return on
Gross Profit Ratio
equity investment and does
not consider the value of
these intangible assets.

Real Estate The ratio doesn’t consider

non-equity financings like
mortgages and loans.

Financial Sector The ratio only looks at equity The ratio doesn’t factor in
investment and doesn’t how debt affects overall
 factor in how debt affects profitability.
overall profitability.

Interest Software It has insignificant interest Debt-to-Equity,

Coverage Ratio expenses due to less
DSCR Ratio
investment in fixed assets.

Biotechnology They have different financing

structures and may not rely
on debt to pay their interest
expenses.

Hospitality It has volatile revenue Volatile revenue streams

streams and non-interest and non-interest expenses
expenses that make the ratio could make this ratio less
less relevant. relevant.

Working Retail They have significant Debt-to-Equity,

Capital inventory turnover, which
Fixed Asset Turnover Ratio
Turnover Ratio impacts revenue more than
working capital
 management.

Biotech They have long operating

cycles and investments in
R&D, and working capital is
not a key revenue driver.

Profit/Earnings Oil and Gas They have higher non-cash EBITDA Ratio,
Ratio items like depreciation and
Price-to-Cash Flow Ratio
amortization.

Technology They have more intangible

assets like patents and
intellectual property that
affect earnings.

Advantages & Disadvantages of Ratio Analysis

Advantages Disadvantages
 It gives valuable insights into the business’s Companies can easily manipulate financial
financial performance. data and generate distorted results.

Assists firms in identifying trends & patterns It is sometimes an issue to compare ratios
in their overall financial health. across sectors and industries.

It is a handy tool for making informed Business environment, needs, and changes
business decisions. can easily impact decisions. Thus decisions
based solely on ratios might not be practical.

Frequently Asked Questions (FAQs)

Q1. What are the limitations of ratio analysis?
Answer: While ratio analysis is a brilliant tool for analyzing and evaluating a company, it only covers the factors like
liquidity, profitability, and solvency. It also gives us limited data regarding a company’s financial performance, not
considering other significant elements, including managerial quality, market trends, and competitive pressures.
Moreover, as every firm is distinct, comparing ratios between businesses with various business structures, strategies,
and risk profiles can be deceptive.
Q2. Which tool is useful for ratio analysis?
Answer: Ratio analysis uses the financial statements of a corporation, such as the balance sheet, income statement,
and cash flow statement. The information in these financial statements can help calculate several financial ratios. The
calculator can be manual, or analysts can use spreadsheet software like Microsoft Excel. Alternatively, several financial
analysis tools and programs can automate the ratio analysis process and visually provide the results. Tools for financial
analysis include Zoho Books, Xero, QuickBooks, and more.
Q3. What is the gearing ratio?
Answer: A gearing ratio is a leverage ratio that assesses how much debt a company uses to fund its activities instead of
equity. It shows how much of a company’s funding comes from creditors rather than investors.

Recommended Articles
This is a guide to Ratio Analysis Types. Here we discuss the introduction and Type of Ratio Analysis, including liquidity,
profitability, and solvency ratios. You may also look at the following articles to learn more –
Statistical Analysis Tools
Limitations of Ratio Analysis
Horizontal Analysis Formula
Current Ratio vs Quick Ratio