Financial Ratios - High Point University

Example Financial Ratios
Liquidity Ratios
1. Current Ratio = Current Assets/Current Liabilities
Example: A current ratio of 3.0: For every dollar of current liabilities, the company has
$3 of current assets.
General Rule: The greater the current ratio, the better—financially stronger.
Profitability Ratios
1. Gross Profit Margin = Gross Profit/Sales
Example: A Gross Profit Margin of 35%: For every dollar of sales, the company has
gross profit of 65 cents.
General Rule: The greater the gross profit margin, the better.
2. Profit Margin or Net Profit Margin = Net Profit/Sales or Net Profit After Taxes/Sales
Net Income = Net Profit = Net Earnings = Net Profit after Taxes
Example: A net profit margin of 10%: For every dollar of sales, the company has net
income of 10 cents.
General Rule: The greater the net profit margin, the better.
3. Return on Assets (ROA) = Net Income/Total Assets
Example: ROA of 7 percent: For every dollar of assets, the company generates 7 cents
of net income
General Rule: The greater the ROA, the better.
4. Return on Equity (ROE) = Net Income/Stockholder Equity
Stockholder equity = owner’s equity = equity
Example: ROE of 15 percent: For every dollar of stockholder equity, the company
generates 15 cents of net income.
General Rule: The greater the ROE, the better.
5. EPS or Earnings Per Share = Net Income/Shares Outstanding
Example: EPS of $3.50: For every share of common stock, the company earns $3.50
General Rule: None—EPS is not comparable. It is driven by the number of shares
Solvency Ratios (aka Debt or Leverage Ratios)
1. Debt Ratio = Total Liabilities/Total Assets
Example: Debt Ratio = 65%: For every dollar of assets, the company is financed with 65
cents of debt and 35 (1-.65) cents of equity. Total financing must equal 100% (65% +
General Rule: The greater the debt ratio, the riskier the company.
2. Times Interest Earned = Earnings Before Interest & Taxes/Interest Expense
EBIT = Earnings Before Interest & Taxes = roughly equals operating income
Example: Times interest earned = 4.0: For every dollar of interest expense, the
company’s operating income equals $4.
General Rule: The lower the times interest earned, the riskier the company. It may imply
that the company has too much debt.
Asset Utilization Ratios (aka Activity or Asset-Management Ratios)
1. Inventory Turnover = Cost of Goods Sold/Inventory
Example: Inventory Turnover of Apples = 180: Say, you have one apple in inventory.
You pay $1 per apple. Every time you sell an apple, your order and receive another
apple. Therefore, your inventory will equal $1. You sell an apple every other day.
Using 360 (not 365—finance oftentimes uses 360 days in a year) days in a year, you
would sell 180 apples per year. Multiplying 180 X 1 = COGS of $180.
Inventory Turnover interpretation: You turn your inventory over 180 times a year.
General rule: The greater your inventory turnover, the better. It implies the product is
“moving off the shelf”.
2. Accounts Receivable Turnover = Sales/Accounts Receivable-Accounts Receivable Turnover—this leads us to average collection period
3. Average Collection Period (days) = 365/Accounts Receivable Turnover
Example: Average Collection Period = 30: This means that on average, it takes 30 days
to collect your receivables.
General Rule: The longer the collection period, the longer your money is tied up. If your
collection period exceeds your terms (e.g., 2/10 net 30), this may be a sign that you have
credit risk . . . that you have some receivables that may never be collected.
Note: All ratios assume no preferred stock