Financial Ratios Overview

Study Notes

Financial Ratios

Assets = Liabilities + Equity This fundamental accounting equation shows the relationship between a company's assets, liabilities, and equity.
Capital Employed = Total Assets – Current Liabilities Indicates the total capital used in a business.
Liquidity Ratios: Evaluate a company's ability to meet its short-term obligations.
- Current Ratio = Current Assets / Current Liabilities Measures the short-term debt-paying ability.
- Quick Ratio = (Current Assets - Inventory) / Current Liabilities A stricter measure of liquidity, excluding inventory, as it's less liquid.
- Cash Ratio = Cash / Current Liabilities The most stringent liquidity measure, focusing solely on cash.
Leverage Ratios: Assess the company's financial leverage, or the extent to which it uses borrowed funds.
- Debt-to-Equity Ratio = Total Liabilities / Equity Shows the proportion of financing from debt versus equity.
- Debt-to-Assets Ratio = Total Liabilities / Total Assets Indicates the percentage of assets financed by debt.
Profitability Ratios: Evaluate a company's profitability.
- Gross Profit Margin = (Gross Profit / Revenue) x 100 Measures the profitability of core operations.
- Gross Profit = Revenue – Cost of Goods Sold (COGS) Calculates the profit generated after deducting COGS.
Efficiency Ratios: Assess how efficiently a company uses its assets and resources.
- Inventory Turnover = COGS / Average Inventory Measures how quickly inventory is sold.
- COGS = Opening Inventory + Purchases – Closing Inventory Calculates the total cost of goods sold.
- Average Inventory = (Opening Inventory + Closing Inventory) / 2 Calculates the average inventory level during a period.
- Receivables Turnover = Revenue / Average Receivables Measures how quickly credit sales are collected.
- Payables Turnover = Purchases / Average Payables Indicates how quickly the company pays its suppliers.
- Asset Turnover = Revenue / Total Assets Measures how efficiently the company uses its assets to generate revenue.
Operational Ratios: Measure how efficiently a company manages its operations.
- Inventory days = Closing inventory / COGS Indicates the number of days inventory remains on hand.
- Payable days = Payables due within one year / Purchases Measures the number of days it takes to pay suppliers.
- Receivable days = Receivables / Revenue Indicates the average number of days it takes to collect receivables.