Explanation of Each Financial Ratios

Tacettin İKİZ · March 06, 2025, 03:40:21 PM

Explanation of Each Financial Ratios

Liquidity Ratios (Measure short-term financial health)

Current Ratio = Current assets ÷ Current liabilities
- Measures ability to pay short-term obligations. Higher (>1) is better.
Quick Ratio = (Cash + Short-term investments + Receivables) ÷ Current liabilities
- Excludes inventory. A ratio >1 is good.
Cash Ratio = (Cash + Short-term investments) ÷ Current liabilities
- The strictest liquidity measure. Higher is safer.
Defensive Interval Ratio = (Cash + Short-term investments + Receivables) ÷ Daily cash expenditures
- Measures how long a company can survive using liquid assets.

Efficiency Ratios (How effectively a company manages assets)

Receivables Turnover Ratio = Total revenue ÷ Average receivables
- Higher means faster collection.
Days of Sales Outstanding (DSO) = Number of days in period ÷ Receivables turnover ratio
- Lower means faster payments.
Inventory Turnover Ratio = Cost of goods sold ÷ Average inventory
- Higher means faster inventory sales.
Days of Inventory on Hand (DOH) = Number of days in period ÷ Inventory turnover ratio
- Lower means faster inventory movement.
Payables Turnover Ratio = Purchases ÷ Average trade payables
- Higher means suppliers are paid faster.
Number of Days Payables = Number of days in period ÷ Payables turnover ratio
- Lower means quicker payments.
Cash Conversion Cycle (CCC) = DOH + DSO - Number of days of payables
- Lower means faster cash flow.

Turnover Ratios (Measure how well assets generate revenue)

Working Capital Turnover = Total revenue ÷ Average working capital
- Higher means more efficient use.
Fixed Asset Turnover = Total revenue ÷ Average net fixed assets
- Higher means better asset utilization.
Total Asset Turnover = Total revenue ÷ Average total assets
- Higher means more efficient use of all assets.

Profitability Ratios (How well a company generates profit)

Gross Profit Margin = Gross profit ÷ Total revenue
- Higher means better profitability after production costs.
Operating Profit Margin = Operating profit ÷ Total revenue
- Higher means better operational efficiency.
Pretax Margin = Earnings before tax but after interest ÷ Total revenue
- Measures profitability before taxes.
Net Profit Margin = Net income ÷ Total revenue
- The final profitability measure.

Return Ratios (Evaluate financial performance)

Operating Return on Assets = Operating income ÷ Average total assets
- Higher means better returns.
Return on Assets (ROA) = Net income ÷ Average total assets
- Measures overall profitability.
Return on Equity (ROE) = Net income ÷ Average shareholders' equity
- Measures how well equity generates profit.
Return on Invested Capital (Pre-tax) = EBIT ÷ (Average debt + Average equity)
- Measures return on all invested capital.
Return on Invested Capital (After-tax) = [(EBIT) × (1 - Effective Tax Rate)] ÷ (Average debt + Average equity)
- Adjusted for taxes.
Return on Common Equity = (Net income - Preferred dividends) ÷ Average common shareholders' equity
- Focuses on common shareholders' return.

Risk & Leverage Ratios

Tax Burden = Net income ÷ Earnings before taxes
- Lower means higher taxes.
Interest Burden = Earnings before taxes ÷ Earnings before interest and taxes
- Lower means more interest costs.
EBIT Margin = EBIT ÷ Total revenue
- Measures profitability before interest and taxes.

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2. Application to Real Data

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3. Financial Analysis & Interpretation

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