Financial Ratios Guide

1. Liquidity Ratios

These ratios assess a company's ability to meet short-term obligations.

A) Current Ratio

Formula:

Current Ratio = Current Assets / Current Liabilities

Interpretation:

Indicates the company's ability to pay short-term obligations. A higher ratio suggests better liquidity.

Good Ratio:

Between 1.2 and 3.

B) Quick Ratio (Acid-Test Ratio)

Formula:

Quick Ratio = (Cash + Cash Equivalents + Marketable Securities + Accounts Receivable) / Current

Liabilities

Interpretation:

Measures liquidity excluding inventory, focusing on assets that can be quickly converted to cash.

Good Ratio:

1 or above.

C) Cash Ratio

Formula:

Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities

Interpretation:

Assesses the company's ability to pay off short-term liabilities with cash or cash equivalents.
Good Ratio:

0.5 or above.

D) Operating Cash Flow Ratio

Formula:

Operating Cash Flow Ratio = Cash from Operations / Current Liabilities

Interpretation:

Evaluates how well current liabilities are covered by the cash flow generated from a company's

operations.

Good Ratio:

1 or above.

2. Profitability Ratios

These ratios measure a company's ability to generate profit relative to revenue, assets, equity, and

other factors.

A) Gross Profit Margin

Formula:

Gross Profit Margin = (Gross Profit / Net Sales) × 100

Interpretation:

Indicates the efficiency of production and pricing strategies by showing the percentage of revenue

exceeding the cost of goods sold.

Good Ratio:

20% or higher.

B) Net Profit Margin

Formula:
Net Profit Margin = (Net Profit / Net Sales) × 100

Interpretation:

Reflects the percentage of revenue that remains as profit after all expenses are deducted.

Good Ratio:

10% or higher.

C) Operating Profit Margin

Formula:

Operating Profit Margin = (Operating Profit / Net Sales) × 100

Interpretation:

Measures the proportion of revenue remaining after covering variable production costs, indicating

operational efficiency.

Good Ratio:

15% or higher.

D) Return on Capital Employed (ROCE)

Formula:

ROCE = (Operating Profit / Capital Employed) × 100

Interpretation:

Measures the efficiency and profitability of a company's capital investments.

Good Ratio:

Above 10%.

E) Return on Assets (ROA)

Formula:

ROA = (Net Income / Total Assets) × 100

Interpretation:
Assesses how effectively a company uses its assets to generate profit.

Good Ratio:

5% or higher.

F) Return on Equity (ROE)

Formula:

ROE = (Net Income / Shareholders' Equity) × 100

Interpretation:

Indicates how efficiently a company is using shareholders' equity to generate profit.

Good Ratio:

15% or higher.

3. Solvency Ratios

These ratios evaluate the extent to which a company is utilizing borrowed money.

A) Debt to Equity Ratio

Formula:

Debt to Equity Ratio = Total Debt / Total Equity

Interpretation:

Compares the company's total debt to its shareholders' equity, indicating how leveraged the

company is.

Good Ratio:

Between 1 and 1.5.

B) Debt to Assets Ratio

Formula:

Debt to Assets Ratio = Total Debt / Total Assets

Shows the proportion of a company's assets that are financed by debt.

Good Ratio:

0.4 or lower.

C) Debt Service Coverage Ratio

Formula:

Debt Service Coverage Ratio = Net Operating Income / Total Debt Service

Interpretation:

Indicates a company's ability to service its debt obligations.

Good Ratio:

Above 1.5.

D) Interest Coverage Ratio

Formula:

Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense

Interpretation:

Measures how easily a company can pay interest expenses on outstanding debt.

Good Ratio:

Above 3.

4. Turnover Ratios

These ratios measure how efficiently a company utilizes its assets.

A) Fixed Assets Turnover Ratio

Formula:

Fixed Assets Turnover = Net Sales / Average Fixed Assets

Indicates how efficiently fixed assets are used to generate sales.

Good Ratio:

Higher is better.

B) Inventory Turnover Ratio

Formula:

Inventory Turnover = Cost of Goods Sold / Average Inventory

Interpretation:

Indicates how many times inventory is sold and replaced over a period.

Good Ratio:

Higher is better.

C) Receivables Turnover Ratio

Formula:

Receivables Turnover = Net Credit Sales / Average Accounts Receivable

Interpretation:

Measures how efficiently a company collects outstanding credit sales.

Good Ratio:

Higher is better.

D) Working Capital Turnover Ratio

Formula:

Working Capital Turnover = Net Sales / Average Working Capital

Interpretation:

Evaluates how efficiently working capital is used to generate sales.

Good Ratio:
Higher is better.

E) Payables Turnover Ratio

Formula:

Payables Turnover = Cost of Goods Sold / Average Accounts Payable

Interpretation:

Measures how quickly a company pays its suppliers.

Good Ratio:

Higher is better.

F) Cash Conversion Cycle Ratio

Formula:

Cash Conversion Cycle = Inventory Days + Receivables Days - Payables Days

Interpretation:

Measures the time required to convert investments in inventory and receivables into cash.

Good Ratio:

Lower is better.

5. Earnings Ratios

A) Profit/Earnings Ratio

Formula:

P/E Ratio = Market Price per Share / Earnings per Share

Interpretation:

Measures how much investors are willing to pay for a company's earnings.

Good Ratio:

Varies by industry.
B) Earnings Per Share (EPS)

Formula:

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

Interpretation:

Represents the portion of a company's profit allocated to each share of common stock.

Good Ratio:

Higher is better.

C) Dividend Yield Ratio

Formula:

Dividend Yield = (Annual Dividends per Share / Market Price per Share) × 100

Interpretation:

Shows the return on investment from dividends.

Good Ratio:

Higher is better.