Financial Ratios

What are Financial Ratios?

Financial ratios are the indicators of the financial performance of companies and there are different types of financial ratios which indicate the company’s results, its financial risks and its working efficiency like the liquidity ratio, Asset Turnover RatioAsset Turnover RatioThe asset turnover ratio is the ratio of a company's net sales to total average assets, and it helps determine whether the company generates enough revenue to justify holding a large amount of assets under the company’s balance sheet.read more, Operating profitability ratios, Business risk ratios, financial risk ratio, Stability ratios etc.

List of Top 28 Financial Ratios with Formulas & Types

Below are the types and list of financial ratios with Formulas

  1. Current ratio
  2. Quick ratio
  3. Absolute liquidity ratio
  4. Cash ratio
  5. Inventory Turnover RatioInventory Turnover RatioInventory Turnover Ratio is a measure to determine the efficiency of a Company concerning its overall inventory management. To calculate the ratio, divide the cost of goods sold by the gross inventory. read more
  6. Receivables Turnover Ratio
  7. Capital Turnover Ratio
  8. Asset Turnover Ratio
  9. Net Working Capital Ratio
  10. Cash Conversion Cycle
  11. Earnings Margin
  12. Return on Investment
  13. Return on Equity
  14. Earnings Per Share
  15. Operating Leverage
  16. Financial leverage
  17. Total Leverage
  18. Debt-Equity Ratio
  19. Interest Coverage Ratio
  20. Debt Service Coverage Ratio
  21. Fixed Asset Ratio
  22. Current Asset to Fixed Asset
  23. Proprietary Ratio
  24. Fixed Interest Cover
  25. Fixed Dividend Cover
  26. Capacity Ratio
  27. Activity Ratio
  28. Efficiency Ratio
Financial Ratios

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Liquidity Ratio Analysis

The first type of financial ratio analysis is the Liquidy Ratio. The liquidity ratio aim is to determine the ability of a business to meet its financial obligations during the short-term and to maintain its short-term debt paying ability. Liquidity ratio can be calculated by multiple ways they are as follows:-

#1 – Current Ratio

The Current ratioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities read more is referred to as a working capital ratio or banker’s ratio. The current ratio expresses the relationship of a current asset to current liabilities.

Formula = Current Assets / Current Liablities

A company’s current ratio can be compared with the past current ratio; this will help to determine if the current ratio is high or low at this period in time.

The ratio of 1 is considered to be ideal that is current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more are twice a current liability, then no issue will be in repaying liability, and if the ratio is less than 2, repayment of liability will be difficult and work effects.

#2 – Acid Test Ratio/ Quick Ratio

The current ratio is generally used to evaluate an enterprise’s overall short-term solvencySolvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.read more or liquidity position, but many times it is desirable to know the more immediate position or instant debt paying ability of a firm than that indicated by the current ratio for this acid test financial ratio is used. It is relating the most liquid assetsLiquid AssetsLiquid Assets are the business assets that can be converted into cash within a short period, such as cash, marketable securities, and money market instruments. They are recorded on the asset side of the company's balance sheet.read more to current liabilities.

Acid Test Formula = (Current Assets -Inventory)/(Current Liability)

The quick ratio can be written as:-

Quick Ratio Formula = Quick Assets / Current Liabilities

Or

Quick Ratio Formula = Quick Assets / Quick Liabilities

#3 – Absolute Liquidity Ratio

Absolute Liquidity helps to calculate actual liquidity, and for that, inventory and receivables are excluded from current assets. For a better view of liquidity, some assets are excluded that may not represent current cash flow. Ideally, the ratio should be 1:2.

Absolute Liquidity = Cash + Marketable SecuritiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more + Net Receivable and Debtors

#4 – Cash Ratio

The Cash ratio is usefulCash Ratio Is UsefulCash Ratio is calculated by dividing the total cash and the cash equivalents of the company by total current liabilities. It indicates how quickly a business can pay off its short term liabilities using the non-current assets.read more for a company that is undergoing is financial trouble.

Cash Ratio Formula = Cash + Marketable Securities / Current Liability

If the ratio is high, then it reflects the underutilization of resources, and if the ratio is low, then it can lead to a problem in repayment of bills.

Turnover Ratio Analysis

The second type of financial ratio analysis is the Turnover Ratio. The turnover ratio is also known as activity ratio. This type of ratio indicates the efficiency with which an enterprise’s resources are utilized. For each asset type, the financial ratio can be calculated separately.

The following are financial ratios commonly calculated:-

#5 – Inventory Turnover Ratio

This financial ratio measures the relative size of inventory and influences the amount of cash available to pay liabilities.

Inventory Turnover Ratio Formula = Cost of Goods Sold / Average Inventory

#6 – Debtors or Receivable Turnover Ratio

The receivable turnover ratio shows how many times the receivable was turned into cash during the period.

Receivable Turnover Ratio Formula = Net Credit SalesNet Credit SalesNet credit sales is the revenue generated from goods or services sold on credit excluding the sales discount, sales allowance and sales return. It even amounts to the accounts receivables for a certain accounting period.read more / Average Accounts Receivable

#7 – Capital Turnover Ratio

The capital turnoverCapital TurnoverCapital turnover determines the organization's capital utilization efficiency and is calculated as a ratio of total annual turnover divided by the total amount of stockholder's equity. The higher the ratio, the better the utilization of the capital employed.read more ratio measures the effectiveness with which a firm uses its financial resources.

Capital Turnover Ratio Formula = Net Sales (Cost of Goods Sold) / Capital Employed

#8 – Asset Turnover Ratio

This financial ratio reveals the number of times the net tangible assetsNet Tangible AssetsNet Tangible Assets is the value derived from the company's total assets minus all intangible assets. Net Tangible Assets per share is calculated by dividing the net assets by the outstanding number of equity shares.read more are turned over during a year. The higher the ratio better it is.

Asset Turnover Ratio Formula = Turnover / Net Tangible Assets

#9 – Net Working Capital Turnover Ratio

This financial ratio indicates whether or not working capital has been effectively utilized in making sales. Net Working capitalNet Working CapitalThe Net Working Capital (NWC) is the difference between the total current assets and total current liabilities. A positive net working capital indicates that a company has a large number of assets, while a negative one indicates that the company has a large number of liabilities.read more signifies the excess of current assets over current liabilities.

Net Working Capital Turnover Ratio Formula = Net Sales / Net Working Capital

#10 – Cash Conversion Cycle

The Cash conversion cycleCash Conversion CycleThe Cash Conversion Cycle (CCC) is a ratio analysis measure to evaluate the number of days or time a company converts its inventory and other inputs into cash. It considers the days inventory outstanding, days sales outstanding and days payable outstanding for computation.read more is the total time taken by the firm to convert its cash outflows into cash inflows (returns).

Cash Conversion Cycle Formula = Receivable Days + Inventory Days – Payable Days

Operating Profitability Ratio Analysis

The third type of financial ratio analysis is the Operating Profitability Ratio. The profitability ratio helps to measure the profitability of a company through this efficiency of business activity. The following are the important profitability ratiosImportant Profitability RatiosProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more:-

#11 – Earning Margin

It is the ratio of net income to turnover express in percentage. It refers to the final net profit used.

Earning Margin formula = Net Income / Turnover * 100

#12 – Return on Capital Employed or Return On the Investment

This financial ratio measures profitability in relation to the total capital employed in a business enterprise.

Return on Investment formula = Profit Before Interest and Tax / Total Capital Employed

#13 – Return On Equity

Return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more is derived by taking net income and dividing it by shareholder’s equity; it provides a return that management is realizing from the shareholder’s equity.

Return on Equity Formula = Profit After Taxation – Preference Dividends / Ordinary Shareholder’s Fund * 100

#14 – Earnings Per Share

EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more is derived by dividing the profit of the company by the total number of shares outstanding. It means profit or net earnings.

Earnings Per Share Formula = Earnings After Taxation – Preference Dividends / Number of Ordinary Shares

The investor uses all the above ratio before investing and make maximum profit and analyze risk. Through ratio, it is easy for him to compare and predict the future growth of a company. It also simplifies the financial statementFinancial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.

Business Risk Ratios

The fourth type of financial ratio analysis is the Business Risk Ratios. Here we measure how sensitive is the company’s earnings with respect to its fixed costs as well as the assumed debt on the balance sheet.

#15 – Operating Leverage

Operating leverageOperating LeverageOperating Leverage is an accounting metric that helps the analyst in analyzing how a company’s operations are related to the company’s revenues. The ratio gives details about how much of a revenue increase will the company have with a specific percentage of sales increase – which puts the predictability of sales into the forefront.read more is the percentage change in operating profit relative to sales, and it measures how sensitive the operating income is to the change in revenues. Greater the use of fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more, the greater the impact of a change in sales on the operating income of a company.

Operating Leverage Formula = % change in EBIT / % change in Sales

#16 – Financial Leverage

Financial leverage is the percentage change in Net profit relative to Operating Profit, and it measures how sensitive the Net Income is to the change in Operating Income. Financial leverage primarily originates from the company’s financing decisions (usage of debt).

Financial Leverage formula = % change in Net Income / % change in EBIT

#17 – Total Leverage

Total leverage is the percentage change in Net profit relative to its Sales. Total leverage measures how sensitive the Net Income is to the change in Sales.

Total Leverage Formula = % change in Net Profit / % change in Sales

Financial Risk Ratio Analysis

The fifth type of financial ratioType Of Financial RatioFinancial ratios are of five types which are liquidity ratios, leverage financial ratios, efficiency ratio, profitability ratios, and market value ratios. These ratios analyze the financial performance of a company for an accounting period.read more analysis is the Financial Risk Ratio. Here we measure how leveraged the company is and how it is placed with respect to its debt repayment capacity.

#18 – Debt Equity Ratio

Debt Equity Formula = Long Term Debts / Shareholder’s Fund

It helps to measures the extent of equity to repay debt. It is used for long-term calculation.

#19 – Interest Coverage Ratio Analysis

This financial ratio signifies the ability of the firm to pay interest on the assumed debt.

Interest Coverage Formula = EBITDA / Interest Expense

  • Higher interest coverage ratios imply the greater ability of the firm to pay off its interests.
  • If Interest coverage is less than 1, then EBITDA is not sufficient to pay off interest, which implies finding other ways to arrange funds.

#20 – Debt Service Coverage Ratio (DSCR)

Debt Service Coverage RatioDebt Service Coverage RatioDebt service coverage (DSCR) is the ratio of net operating income to total debt service that determines whether a company's net income is sufficient to cover its debt obligations. It is used to calculate the loanable amount to a corporation during commercial real estate lending.read more tells us whether the Operating Income is sufficient to pay off all obligations that are related to debt in a year.

Debt Service Coverage Formula = Operating Income / Debt Service

Operating Income is nothing but EBIT

Debt Service is Principal Payments + Interest Payments + LeasePayments + Interest Payments + LeaseLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration.read more Payments

  • A DSCR of less than 1.0 implies that the operating cash flows are not sufficient enough for Debt Servicing, implying negative cash flows.

Stability Ratios

The sixth type of financial ratio analysis is the Stability Ratio. The stability ratio is used with a vision of the long-term. It uses to check whether the company is stable in the long run or not. This type of ratio analysis can be calculated by multiple ways they are as follows:-

#21 – Fixed Asset Ratio

This ratio is used to know whether the company is having sufficient fun or not to meet the long-term business requirement.

Fixed Asset Ratio Formula = Fixed Assets / Capital Employed

The ideal ratio is 0.67. If the ratio is less than 1 then it can be used to purchase fixed assets.

#22 – Ratio to Current Assets to Fixed Assets

Ratio to Current Assets to Fixed Assets = Current Assets / Fixed Assets

If ratio increases, profit increase and reflect business is expanding, whereas if ratio decreases means trading is loose.

#23 – Proprietary Ratio

The proprietary ratio is the ratio of shareholder funds upon total tangible assets; it tells about the financial strength of a company. Ideally, the ratio should be 1:3.

Proprietary Ratio Formula = Shareholder Fund / Total Tangible Assets

Coverage Ratios

The seventh type of financial ratio analysis is the coverage Ratio. This type of ratio analysisRatio AnalysisRatio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.read more is used to calculate dividend, which needs to be paid to investors or interest to be paid to the lender. The higher the cover, the better it is. It can be calculated by the below ways:-

#24 – Fixed Interest Cover

It is used to measure business profitability and its ability to repay the loan.

Fixed Interest Cover Formula = Net Profit Before Interest and Tax / Interest Charge

#25 – Fixed Dividend Cover

It helps to measure dividend need to pay to the investor.

Fixed Dividend Cover Formula = Net Profit Before Interest and Tax / Dividend on Preference Share

Control Ratio Analysis

The eighth type of financial ratio analysis is the Control Ratio. Control ratio from the name itself, it is clear that its use to control things by management. This type of ratio analysis helps management to check favorable or unfavorable performance.

#26 – Capacity Ratio

For this type of ratio analysis, the formula given below will be used for the same.

Capacity Ratio Formula = Actual Hour Worked / Budgeted Hour * 100

#27 –  Activity Ratio

To calculate a measure of activity below, the formula is used.

Activity Ratio Formula = Standard Hours for Actual Production / Budgeted Standard Hour * 100

#28 – Efficiency Ratio

To calculate productivity below formula is used.

Efficiency Ratio Formula = Standard Hours for Actual Production / Actual Hour Worked * 100

If a percentage is 100 or more, it is considered to be as favorable; if a percentage is less than 100%, then it is unfavorable.

Financial Ratios Video

 

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This has been a guide to Financial Ratio Analysis. Here we provide a comprehensive list of 28 financial ratios formulas, types, and interpretation. You may learn more about ratio analysis from the following articles –

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