Key Financial Ratios


Financial ratios are essential tools used to evaluate a company's financial performance, profitability, liquidity, and overall health. 

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1. Efficiency Ratios 
These ratios measure how effectively a company uses its assets and manages its operations. 

Inventory Turnover 
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory 
- Measures how many times a company's inventory is sold and replaced over a period. 

Example: 
- Cost of Goods Sold (COGS) = $1,000,000 
- Average Inventory = $200,000 
Inventory Turnover = $1,000,000 ÷ $200,000 = 5 
→ The company replaces its inventory 5 times per year. 

Asset Turnover 
Asset Turnover = Sales ÷ Total Assets 
- Measures how efficiently a company uses its assets to generate revenue. 

Example: 
- Sales = $2,000,000 
- Total Assets = $500,000 
Asset Turnover = $2,000,000 ÷ $500,000 = 4 
→ The company generates $4 in sales for every $1 in assets. 

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2. Liquidity Ratios 
These ratios measure a company's ability to meet short-term obligations. 

Current Ratio 
Current Ratio = Current Assets ÷ Current Liabilities 
- Measures the ability to pay short-term debts. 

Example: 
- Current Assets = $400,000 
- Current Liabilities = $200,000 
Current Ratio = $400,000 ÷ $200,000 = 2 
→ A current ratio of 2 means the company has twice the assets to cover liabilities. 

Quick Ratio 
Quick Ratio = (Current Assets – Inventory) ÷ Current Liabilities 
- Similar to current ratio but excludes inventory (less liquid). 

Example: 
- Current Assets = $400,000 
- Inventory = $100,000 
- Current Liabilities = $200,000 
Quick Ratio = ($400,000 – $100,000) ÷ $200,000 = 1.5 
→ The company has $1.5 in quick assets for every $1 in liabilities. 

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3. Coverage Ratios 
These ratios measure how easily a company can pay its debts and interest expenses. 

Interest Coverage Ratio 
Interest Coverage Ratio = EBIT ÷ Interest Expenses 
- Measures how easily a company can cover its interest payments. 

Example: 
- EBIT = $100,000 
- Interest Expense = $20,000 
Interest Coverage Ratio = $100,000 ÷ $20,000 = 5 
→ The company can cover its interest expenses 5 times over. 

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4. Profitability Ratios 
These ratios measure how effectively a company generates profit relative to its revenue or assets. 

Return on Assets (ROA) 
ROA = Net Income ÷ Total Assets 
- Measures how efficiently a company uses its assets to generate income. 

Example: 
- Net Income = $50,000 
- Total Assets = $500,000 
ROA = $50,000 ÷ $500,000 = 10% 
→ The company generates 10% profit on its total assets. 

Return on Equity (ROE) 
ROE = Net Income ÷ Shareholder's Equity 
- Measures how effectively a company uses shareholders' equity to generate income. 

Example: 
- Net Income = $50,000 
- Shareholder's Equity = $200,000 
ROE = $50,000 ÷ $200,000 = 25% 
→ The company generates a 25% return on shareholder equity. 

Gross Margin 
Gross Margin = Gross Profit ÷ Revenue 
- Measures how much of each dollar in sales is retained as gross profit. 

Example: 
- Gross Profit = $400,000 
- Revenue = $1,000,000 
Gross Margin = $400,000 ÷ $1,000,000 = 40% 

Net Profit Margin 
Net Profit Margin = Net Income ÷ Revenue 
- Measures how much of each dollar in sales is retained as net profit. 

Example: 
- Net Income = $100,000 
- Revenue = $1,000,000 
Net Profit Margin = $100,000 ÷ $1,000,000 = 10% 

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5. Dividend Ratios 

Dividend Payout Ratio 
Dividend Payout Ratio = Dividends ÷ Net Income 
- Measures what proportion of earnings is paid as dividends. 

Example: 
- Dividends = $20,000 
- Net Income = $50,000 
Dividend Payout Ratio = $20,000 ÷ $50,000 = 40% 

Dividend Yield 
Dividend Yield = Annual Dividend per Share ÷ Price per Share 

Example: 
- Annual Dividend = $2 
- Price per Share = $40 
Dividend Yield = $2 ÷ $40 = 5% 

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6. Leverage Ratios 

Debt-to-Equity Ratio 
Debt-to-Equity Ratio = Total Debt ÷ Total Equity 

Example: 
- Total Debt = $100,000 
- Total Equity = $200,000 
Debt-to-Equity Ratio = $100,000 ÷ $200,000 = 0.5 

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7. Market Value Ratios 

Price to Earnings Ratio (P/E) 
P/E Ratio = Stock Price ÷ Earnings per Share 

Example: 
- Stock Price = $50 
- EPS = $5 
P/E Ratio = $50 ÷ $5 = 10x 

Price to Sales Ratio (P/S) 
P/S Ratio = Stock Price ÷ Sales per Share 

Example: 
- Stock Price = $40 
- Sales per Share = $10 
P/S Ratio = $40 ÷ $10 = 4x 

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✅ Summary Example: 

Category	Example	Result
Current Ratio	400,000 ÷ 200,000	2.0
ROA	50,000 ÷ 500,000	10%
Debt-to-Equity	100,000 ÷ 200,000	0.5
P/E Ratio	50 ÷ 5	10x

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