Key Financial Ratios for Business Performance Analysis

Efficiency Ratios

Inventory Turnover

Determines if sales are sufficient to turn over or utilize inventory effectively. It indicates whether too much or insufficient inventory is being purchased.

Assets Turnover

A higher Assets Turnover Ratio (ATR) suggests that the company's management is utilizing its assets efficiently to generate sales.

Receivables Turnover

A higher receivables turnover indicates that a company is more efficient than its competitors in collecting its accounts receivables.

Profitability Ratios

Return on Sales (RoS)

"For every dollar sold, the company earns x profit." Measures operational efficiency.

Return on Equity (RoE)

"For every dollar invested by shareholders, the company earns x profit." Measures profitability relative to shareholders' equity.

Return on Assets (RoA)

"For every dollar invested in assets by the company, it earns x profit." Measures how profitably a company uses its assets.

Liquidity Ratios

Liquidity refers to an enterprise's capacity to meet its short-term financial commitments, meaning it has enough liquid assets to pay its immediate bills.

Current Ratio (CR)

Measures a company's ability to pay off its current liabilities with its current assets.

Acid-Test Ratio (Quick Ratio)

Measures a company's ability to meet its short-term obligations with its most liquid assets (excluding inventory).

Solvency Ratios

Solvency refers to an enterprise's capacity to meet its long-term financial commitments. A solvent company owns more than it owes, indicating long-term financial health.

Debt-to-Equity (DtoE) Ratio

Indicates the degree of financial leverage being used by the business. A rising DtoE ratio implies higher interest expenses and may negatively affect a company's credit rating, making it more expensive to raise debt.

Times Interest Earned (TIE)

Measures the ability to meet the interest expense on its debt using Earnings Before Interest and Taxes (EBIT). The higher the ratio, the better the company's ability to cover its interest expenses.

Financial Ratio Formulas

• Current Ratio: Current Assets / Current Liabilities
• Acid-Test Ratio: Liquid Assets / Current Liabilities (Liquid Assets = Cash + Receivables + Short-term Investments)
• Receivables Turnover Ratio: Net Credit Sales / Average Accounts Receivable
• Receivable Days (DSO): 365 / Receivables Turnover Ratio
• Inventory Turnover Ratio: Cost of Goods Sold (COGS) / Average Inventory
• Inventory Days (DIO): 365 / Inventory Turnover Ratio
• Payable Turnover Ratio: COGS / Average Accounts Payable
• Payable Days (DPO): 365 / Payable Turnover Ratio
• Long-Term Debt Ratio: Long-Term Debt / (Total Equity + Total Liabilities) (Note: Denominator is often Total Capital)
• Debt-to-Equity Ratio: Total Liabilities / Total Equity
• Debt Ratio: Total Liabilities / Total Assets
• Gross Profit Ratio: Gross Profit / Sales Revenue
• Return on Sales (RoS) / Net Profit Margin: Net Income / Net Sales
• Return on Equity (RoE): Net Income / Average Shareholder Equity (or RoA x Financial Leverage)
• Return on Assets (RoA): Net Income / Average Total Assets (or RoS x Asset Turnover)
• Total Asset Turnover: Sales Revenue / Average Total Assets
• Times Interest Earned (TIE): Operating Income (EBIT) / Interest Expense
• Financial Leverage: Average Total Assets / Average Shareholder Equity
• Earnings Per Share (EPS): Net Income / Average Outstanding Shares
• Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings Per Share (EPS)