Accounting

Ratios

Ratios are fundamental tools in financial analysis that provide insights into a company’s performance, financial health, and valuation. They help investors, analysts, and financial professionals assess various aspects of a company’s operations and make informed decisions. Here are some common ratios used in financial calculations:

**1. Liquidity Ratios:

  • Current Ratio: Current Assets / Current Liabilities – Measures short-term liquidity and the ability to cover short-term obligations.
  • Quick Ratio (Acid-Test Ratio): (Current Assets – Inventory) / Current Liabilities – Measures short-term liquidity without considering inventory.

**2. Profitability Ratios:

  • Gross Profit Margin: (Gross Profit / Revenue) x 100 – Indicates the profitability of core operations.
  • Net Profit Margin: (Net Income / Revenue) x 100 – Measures overall profitability.
  • Return on Assets (ROA): (Net Income / Total Assets) – Measures profitability relative to total assets.
  • Return on Equity (ROE): (Net Income / Shareholders’ Equity) – Measures profitability relative to shareholders’ equity.

**3. Efficiency Ratios:

  • Inventory Turnover: Cost of Goods Sold / Average Inventory – Measures how quickly inventory is sold.
  • Accounts Receivable Turnover: Revenue / Average Accounts Receivable – Measures the efficiency of collecting receivables.
  • Asset Turnover: Revenue / Average Total Assets – Evaluates how efficiently assets are used to generate sales.

**4. Leverage Ratios:

  • Debt to Equity Ratio: Total Debt / Shareholders’ Equity – Evaluates the level of financial leverage.
  • Interest Coverage Ratio: Earnings Before Interest and Taxes (EBIT) / Interest Expense – Assesses the ability to cover interest payments.

**5. Valuation Ratios:

  • Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings per Share – Measures stock price relative to earnings.
  • Price-to-Sales (P/S) Ratio: Market Price per Share / Revenue per Share – Assesses stock price relative to revenue.
  • Price-to-Book (P/B) Ratio: Market Price per Share / Book Value per Share – Compares stock price to the book value of equity.

**6. Coverage Ratios:

  • Times Interest Earned (TIE) Ratio: EBIT / Interest Expense – Measures the ability to cover interest payments.

**7. Dividend Ratios:

  • Dividend Yield: Dividends per Share / Market Price per Share – Indicates the dividend income relative to the stock’s price.
  • Payout Ratio: Dividends per Share / Earnings per Share – Measures the portion of earnings paid out as dividends.

**8. Market Ratios:

  • Market Capitalization: Market Price per Share x Total Outstanding Shares – Calculates the total market value of a company’s equity.
  • Enterprise Value: Market Capitalization + Total Debt – Cash & Cash Equivalents – Represents the theoretical takeover price for the entire company.

These ratios provide a broad range of insights into a company’s financial performance, risk, and valuation. Depending on the specific questions or objectives of the analysis, different ratios may be more relevant. Financial analysts often use a combination of ratios and other financial metrics to assess a company comprehensively. Comparing a company’s ratios to industry benchmarks and historical performance can also provide valuable context for interpretation.