Common Financial Ratios
Central to financial analysis is the calculation of financial ratios. A ratio has a numerator
and a denominator, which converts the financial data to a percentage. This provides one
approach to standardize financial information for useful comparisons. The major ratio
categories and the questions they attempt to answer are:
Liquidity
Activity
Leverage
Performance
Does the company have enough cash and current assets to pay
obligations as they come due?
How efficient are the operations of the company?
What is the mix of equity to debt?
How profitable is the company?
Common liquidity ratios are:
Ratio
Current
Quick (Acid Test)
Cash
Operating Cash
Flow
Calculation
Current Assets / Current
Liabilities
(Cash + Marketable
Securities + Net
Receivables) / Current
Liabilities
(Cash + Marketable
Securities) / Current
Liabilities
Cash Flows from Operations
/ Current Liabilities
Discussion
Standard ratio to evaluate working
capital.
This ratio eliminates inventory and
other current assets from the
denominator, focusing on “near
cash” and receivables.
Only cash and cash equivalents
considered for payment of current
liabilities.
Evaluates cash-related performance
(as measured from the Statement of
Cash Flows) relative to current
liabilities.
Common activity ratios are:
Ratio
Inventory
Turnover
Ratio
COGS / Average
Inventory
Receivables
Turnover
Sales / Average
Accounts
Receivables
Payables Turnover
Working Capital
Turnover
Fixed Asset
Turnover
Sales / Average
Accounts Payables
Sales / Average
Working Capital
Sales / Average
Fixed Assets
Total Asset
Turnover
Sales / Average
Total Assets
Discussion
Measures inventory management.
Inventory should be turned over rapidly,
rather than accumulating in warehouses.
Measures the effectiveness of credit
policies and needed level of receivables
investment for sales. (Also called the
collection period).
Payables represent a financing source for
operations.
Measures how much working (operating)
capital is needed for sales.
Measures the efficiency of net fixed asset
(property, plant & equipment after
accumulated depreciation) investments.
Represents the overall (comprehensive)
efficiency of assets to sales.
Activity ratios can be converted to days “held,” measures that are easily compared across
firms:
Ratio
Average Days Inventory in Stock
Average Days Receivables Outstanding
Average Days Payable Outstanding
Length of Operating Cycle
Calculation
365 / Inventory Turnover
365 / Receivables Turnover
365 / Payables Turnover
365 [(1 / Inventory Turnover) +
(1 / Receivables Turnover)] ; equivalent to
average days inventory + average days
receivables outstanding
Common leverage ratios are:
Ratio
Debt to Equity
Calculation
Total Liabilities / Total
Stockholders’ Equity
Debt Ratio
Total Liabilities / Total
Assets
(Net Income + Interest
Expense + Tax Expense)
/ Interest Expense
Interest Coverage
(Times Interest
Earned)
Long-term Debt to
Equity
Debt to Market
Equity
Long-term Liabilities /
Total Stockholders’
Equity
Total Liabilities at Book
Value / Total Equity at
Market Value
Discussion
Direct comparison of debt to equity
stakeholders and the most common
measure of capital structure.
A broader definition, stating debt as a
percent of assets.
This is a direct measure of the firm’s
ability to meet interest payments,
indicating the protection provided
from current operations.
A long-term perspective of debt and
equity positions of stakeholders
Market valuation may represent a
better measure of equity than book
value. Most firms have a market
premium relative to book value.
Common profitability ratios are:
Ratio
Gross Margin
Calculation
(Sales – COGS) / Sales
Return on Sales
Net Income / Sales
Return on Assets
Net Income / Average
Total Assets
Pretax Return on
Assets
Earnings Before Interest
& Taxes / Average Total
Assets
Net Income / Average
Total Stockholders’
Equity
Common Dividends / Net
Income
Return on Total
Equity
Dividend Payout
Discussion
This captures the relationship
between sales and manufacturing
(or merchandising) costs. (Also,
called the gross profit margin.)
Measures the relationship of the
bottom line to sales and thus
captures sales to total costs of sales.
(Also called the net profit margin).
Measures the firm’s efficiency in
using assets to generate earnings.
Alternatively stated, it captures
earnings to all providers of capital
Measures earnings from operations
on a pretax and pre-interest expense
basis.
Measures earnings to owners as
measured by net assets.
Measures the percent of earnings
paid out to common stockholders.
Du Pont Model:
Ratio
Profitability (Return on Sales) x
Activity (Asset Turnover)
= Return on Assets
x Solvency (Common Equity Leverage)
= Return on Equity
Calculation
Net Income / Sales
Sales / Average Total Assets
Net Income / Average Total Assets
Average Total Assets / Average Common
Equity
Net Income / Average Common Equity
Below are some alternative ratios:
Liquidity
Cash to Current Assets
Cash Position
Current Liability Position
Leverage
Bonded Debt to Equity
Debt to Tangible Net Worth
Activity
Cash Turnover
Payables Turnover
Profit
Operating Profit Margin
Pretax Profit Margin
Return on Common Equity
Financial Leverage Index
(Cash + Marketable Securities) / Current Assets
Cash / Total Assets
Current Liabilities / Total Assets
Bonded Debt / Stockholders’ Equity
Total Liabilities / (Common Equity – Intangible Assets)
Sales / Average Cash (which usually includes marketable
securities)
Sales / Average Accounts Payable
Income From Continuing Operations (After Tax) / Sales
Income Before Tax / Sales
(Net Income – Preferred Dividends) / Average Common
Equity
Return on Equity / Return on Assets
A Summary of Market Ratios
Book Value Per
Share
Earnings- based
Growth Models
Market-to-book
Price Earnings
Ratio (PE)
Price Earnings
Growth Ratio
(PEG)
Sales-to-market
Value
Dividend Yield
Total Stockholders’ Equity /
Number of Shares Outstanding
P = kE / (r-g), where E=earnings,
k=dividend payout rate,
r=discount rate, & g=earnings
growth rate
(Stock Price x Number of Shares
Outstanding) / Total
Stockholders’ Equity
Stock Price / EPS
Equity or net assets, as measured
on the balance sheet
Valuation models that discount
earnings and dividends by a
discount rate adjusted for future
earnings growth
Measure of accounting-based
equity
Measure of market premium paid
for earnings and future
expectations
PE / Earnings Growth Rate
PE compared to earnings growth
rates, a measure of PE
“reasonableness”
Sales / (Stock Price x Number of A sales activity ratio based on
Shares Outstanding)
market price
Dividends Per Share / Stock
Direct cash return on stock
Price
investment