The value of financial ratios is that they provide a consistent and common measurement that can be used to compare companies within the same industry.

For example, if you have two companies with the same debt-to-equity ratio and return on equity, then you can assume that these two companies are similar in terms of their efficiency and profitability.

However, it’s important to note that not all ratios are created equal—some may be more relevant than others depending on what industry you’re looking at. For example, if your company sells products over the internet but only has physical stores in certain locations (i.e., Amazon vs Walmart), then comparing their profit margins would not be fair since Walmart has brick-and-mortar operations where Amazon does not need them as much (or at all).

liquidity ratio

The liquidity ratio measures a company’s ability to pay its debts. It is calculated by dividing current assets by current liabilities, and it is one of the most important financial ratios in corporate finance and accounting.

The current ratio can be broken into two components: quick ratio (also known as acid-test ratio) and cash ratio. Both are important indicators of financial strength, but they measure different things:

• The quick ratio measures how easily a firm can pay off its short-term debts that are due within one year, without having to sell any inventory or use up any of its working capital; in other words, it measures how quickly the firm could pay off its creditors if it had to do so immediately (i.e., “quickly”)
• The cash ratio measures the amount of cash on hand compared with total current liabilities; this includes only those accounts payable that are less than 90 days old

current ratio 

The current ratio is a liquidity ratio that measures the short-term ability of a company to pay its short-term obligations. The current ratio is calculated by dividing total current assets by total current liabilities.

quick ratio

The quick ratio measures the company’s ability to meet its short-term obligations with its most liquid assets. The quick ratio is calculated by dividing the sum of cash and marketable securities by current liabilities.

The companies that have a low current ratio may not be able to pay their debts in time, which may lead to bankruptcy or restructuring.

cash ratio

The cash ratio is the relationship between current assets and current liabilities. It is a liquidity ratio that measures the amount of liquid funds available to meet obligations due within one year, such as accounts payable and accrued expenses.

The formula for calculating the cash ratio is:

{Cash Ratio} = {Current Assets} \ {Current Liabilities}

operating cash flow ratio

The operating cash flow ratio is a measure of a company’s ability to generate cash from its business operations. It is calculated by dividing the operating cash flow by the total debt.

This ratio measures a company’s ability to generate cash, which is important because it can be used for paying back debts or investing in future production capacities. A higher number means that you can pay off your debts more quickly with profits from sales and avoid going bankrupt. However, if this ratio is low and there are no signs of improving, then it may indicate that your company won’t survive very long without going into bankruptcy protection (i.e., declaring bankruptcy).

PROFITABILITY RATIO

Profitability ratios are used to measure how well a company is doing. They can show you if the company has been making money, or if it is losing money. The profitability ratios include:

• Net profit ratio (NPM) – Net profit divided by sales. This shows how much money the company made on each dollar of sales.
• Operating profitability ratio (OPR) – Income from operations divided by total sales revenue. This helps you understand if a firm’s operating costs are increasing or decreasing relative to its revenues and profits

net profit ratio

The net profit  ratio (also called the return on equity ratio) is a financial ratio that measures how much profit the company makes on each dollar of sales. It’s calculated by dividing net income by total shareholders’ equity, and it tells you how much money the company generates for every dollar invested in it. This can be expressed as follows:

operating profitability  ratio

Operating profitability ratio is a financial measure that attempts to assess the efficiency of a company’s operations by measuring the relationship between net revenue and operating expenses. The ratio can be calculated in a number of ways:

• Sales / Operating Expenses
• Net Income / Total Assets
• Net Income / Total Liabilities

return on equity  ratio

Return on equity (ROE) is a measure of how well the company uses its equity to generate earnings. It is calculated by dividing the net income by the stockholders’ equity. The higher the ROE, the better.

return on asset  ratio

Return on assets (ROA) is a financial ratio that shows how well a company is using its assets to generate earnings. It’s calculated by dividing net income by total assets.

The higher the ROA, the better. Because it takes into account both debt and equity, ROA can be a useful metric to compare two companies with different capital structures, though you’ll want to keep in mind that a more leveraged business will have a lower return on capital than one with less debt or equity financing available at its disposal.

LEVERAGE RATIO

The leverage ratio is one of the most basic financial ratios and it’s also one of the most important. The leverage ratio measures a company’s financial risk by dividing total debt by total assets. A higher leverage ratio indicates that a company is using more debt to finance its operations, which means that in times of stress or crisis, creditors will be the first to lose their money.

A lower leverage ratio indicates that a company has less liabilities and therefore less risk for investors who lend them money (i.e., you).

   Debt to equity ratio  

The debt to equity ratio is also known as the debt ratio. This financial ratio measures the extent to which a company has used debt financing in its capital structure. The higher the ratio, the more debt is being used.

For example, if a company’s total assets are $1 million and its total equity is $500,000 then its debt-to-equity ratio would be 2:1 (2/1). Alternately, let’s say that their total assets are $5 million and their total equity is $4 million, then their debt-to-equity ratio would be 1:5 (1/5).

Financial leverage

A company’s financial leverage is the ratio of its long-term debt to its equity. Higher leverage increases risk and lower leverage reduces risk, but there are different types of risk you need to consider.

debt ratio

The debt ratio is the ratio of total debt to total equity. It is also called the gearing ratio and is used to measure the extent of leverage in a company’s capital structure. The higher a business’ debt ratio, the more risky its financial position will be.

The formula for calculating this ratio looks like this:

interest coverage  ratio

The interest coverage ratio is a measure of the ability of a company to meet its financial obligations. It measures the relationship between operating income and interest expenses. The formula for this ratio is:

• [Operating Income / Interest Expense] * 100 = Interest Coverage Ratio

The higher the ratio, the better it is for creditors because they know that there will be enough money left over after paying operating costs and other expenses to pay their interest. A ratio greater than 1 means that you can cover your interest payments with your profits; a value below 1 indicates that you cannot make enough profit to maintain your current level of debt due or exceed it.

debt service coverage  ratio

The debt service coverage ratio measures the ability of a firm to meet its debt obligations. It is calculated by dividing cash flow from operating activities by total interest expense. The higher this ratio, the more liquid a company is and thus has more funds available to pay down its debts. This can be used as an indicator of how well-protected you are against financial risks.

 

 

EFFICIENCY RATIO

The efficiency ratio measures the ratio of operating expenses to revenue. It is one of the most important financial ratios used by investors, lenders and analysts to determine how well a company is using its assets to generate a return on investment.

The higher your organization’s efficiency ratio (ER), the better it is able to use its assets and resources efficiently in generating sales or profit for shareholders or other stakeholders. If your ER is too low, this could mean that you need to reevaluate how much money you are spending on various things such as advertising, marketing campaigns, payroll costs or even rent payments on office space.

asset turnover  ratio

Asset turnover ratio is a measure of how efficiently a company uses its assets to generate revenue. It’s calculated by dividing net sales by average total assets (monthly or annual) and is expressed as follows:

Asset Turnover Ratio = Net Sales / Average Total Assets The asset turnover ratios are calculated for each quarter, and the resulting values are averaged into an “annual” number using an arithmetic mean or weighted average method depending on the type of industry being analyzed.

inventory turnover  ratio

The inventory turnover ratio is a measure of how well a company uses its inventory to generate sales. It is calculated by dividing cost of goods sold by average inventory, as follows:

• Inventory Turnover = Cost of Goods Sold ÷ Average Inventory

A high turnover ratio indicates that the company is not carrying much inventory, which means it does not need as much capital tied up in its business. However, if you look at this on an absolute basis and compare one company’s turnover ratio with another’s without taking into account their size or other factors (such as industry), it may not tell you anything useful about the health of either firm because they are likely to have different degrees of financial leverage and other characteristics that will influence their overall performance metrics such as profit margin and return on assets

receivable turnover  ratio

Receivables turnover ratio is the ratio of net sales to average accounts receivable. This ratio indicates how many times in a given period (usually one year) a company collects its outstanding invoices and thus gets paid by its customers. A higher receivables turnover ratio indicates that the company has been able to collect debt from sales more quickly than its competitors, which implies that it has probably done better than its competitors in terms of credit collection or other factors that affect cash flow from operations (such as timely payment by suppliers).

days sales in inventory

The days sales in inventory (DSI) ratio is a financial metric that compares the value of goods on hand to the amount of business generated over a period of time. It’s defined as follows:

• DSI = (Average Inventory) / (Cost of Goods Sold / 365)
• Average Inventory = Total Inventory – Beginning Inventory + Ending Inventory

In other words, this ratio measures how much inventory sits around for a year before it’s sold. The higher this number, the more unsold inventory you’re likely to have on hand at any given point in time.

MARKET VALUE RATIO

The market value ratio is a financial ratio used to determine how much a company is worth. It compares the market price per share of your stock with its book value per share, or the amount of money it would take for another company to buy all of your stock at once.

It can be calculated by dividing the total market capitalization by total assets. Market cap means the number of shares outstanding multiplied by their price per share, while market value is simply what each shareholder would receive if they cashed out today and sold their shares on the open market.

book value per share ratio

Book value per share is the total value of a company’s assets minus its liabilities. The book value can be calculated as follows:

Book Value = Total Assets – Total Liabilities

This ratio is used to determine the value of a company’s stock, and can also be used to compare companies’ values.

dividend yield ratio

The dividend yield ratio is calculated by dividing the dividend per share by the price per share of a stock:

Dividend Yield Ratio = (Dividends Paid in Year 1 / Price Per Share at Year 1) x 100

This calculation provides an estimate of how much return you get from just holding the stock. It allows you to compare your expected returns on different businesses, or even compare companies within your portfolio.

earnings per share ratio

The earnings per share ratio is the price of a stock divided by its earnings per share. It is also referred to as the price-earnings ratio.

The earnings per share ratio indicates how much investors are willing to pay for each dollar of earnings and can be used to compare companies with similar growth rates but different capital structures. For example, if you want to compare two companies with identical EBITDA (Earnings before interest taxes depreciation and amortization) but differing debt levels, you should use their respective EPS ratios rather than their P/E ratios because the latter does not account for differences between these two firms’ use of debt financing.

price earning ratio

The price-earnings ratio (also known as the P/E) is a measure of how much investors are willing to pay for each dollar of earnings. The formula for this ratio is:

(stock price / earnings per share)

This tells you how many years it would take for a company to earn back its current stock price if it earned the same amount of money every year. For example, if you had $50 million in revenue and made $5 million in net income, your P/E would be 10 ($50M / 1M). If you paid $100 million for that company and they continued earning exactly that amount every year, then your investment would double in value over 10 years ($100M x 2 = 200M).

CONCLUSION

Financial ratios play a crucial role in the analysis of financial statements. They are used to compare different companies, industries and even countries in order to gain insight into their performances. They are also used by entrepreneurs on their financial freedom journey