Current Ratio

The Current Ratio is a liquidity ratio that measures whether or not a

firm has enough resources to meet its short-term obligations. It
compares firm current assets to its current liabilities, and is
expressed as follow:

Current ratio = Current Assets divided by Current liabilities

The Current ratio is an indication of a firm liquidity. Acceptable

current ratios vary from industry to industry. In many cases a
creditor would consider a high current to be better than a low
current ratio, because a high current ratio indicates that the
company is more likely to pay the creditor back. Large current ratios
are not always a good sign for investors. If the company’s current
ratio is too high it may indicate that the company’s current ratio is
too high it may indicate that the company is not effectively using its
current assets or its short-term financing facilities.

If current liabilities exceed current assets the current ratio will be

less than 1. A current ratio of less than 1 indicates that the company
may have problems meeting its short-term obligations. Some types
of businesses can operate with a current ratio of less than one,
however. If inventory turns into cash much more rapidly than the
accounts payable become due, then the firm’s current ratio can
comfortably remain less than one. Inventory is valued at the cost of
acquiring it and the firm intends to sell the inventory for more than
this cost. The sale will therefore generate substantially more cash
than the value of inventory on the balance sheet. Low current ratios
can also be justified for businesses that can collect cash from
customers long before they need to pay their suppliers.
 Liquid Ratio

In finance, the quick ratio, also known as the acid-test ratio is a type
of liquidity ratio which measures the ability of a company to use its
near cash or quick assets to extinguish or retire its current liabilities
immediately. Quick assets include those current assets that
presumably can be quickly converted to cash at close to their book
values. It is the ratio between quickly available or liquid assets and
current liabilities.

A normal liquid ratio is considered to be much better and reliable as

a tool for assessment of liquidity position of firms.

Liquid ratio = Liquid assets divided by current liabilities

Note: the inventory is excluded from the sum of assets in the quick
ratio, but included in the current ratio. Ratios are tests of viability for
business entities but do not give a complete picture of the business
health. If a business has large amounts in accounts receivable which
are due for payment after a long period (say 120 days), and essential
business expenses and accounts payable due for immediate
payment, the quick ratio may look healthy when the business is
actually about to run out of cash. In contrast, if the business has
negotiated fats payment or cash from customers, and long terms
from suppliers, it may have a very low quick ratio and yet be very
healthy.

More detailed analysis of all major payables and receviables in line

with market sentiments and adjustment input data accordingly shall
give more sensible outcomes which shall give actionable insights.
 Debt-to-equity ratio

The debt-to-equity ratio (D/E) is a financial ratio indicating the

relative proportion of shareholders equity and debt used to finance a
company’s assets. Closely related to leveraging, the ratio is also
known as risk, gearing or leverage. The two components are often
taken from the firm’s balance sheet or statement of financial
position (so-called book value), but the ratio may also be calculated
using market values both, if the company’s debt and equity are
publicly traded, or using a combination of book value for debt and
market value for equity financially.

Preferred stock can be considered part of debt or equity. Attributing

preferred shares to one or the other is partially a subjective decision
but will also take into account the specific features of the preferred
shares.

When used to calculate a company’s financial leverage, the debt

usually includes only the Long Term Debt (LTD). Quoted ratios can
even exclude the current portion of the LTD. The composition of
equity and debt and its influence on the value of the firm is much
debated and also described in the Mondigliani miller theorem.

Financial economists and academic papers will usually refer to all

liabilities as debt, and the statement that equity plus liabilities equals
assets is therefore an accounting identity (it is, by definition, true).
Other definitions of debt to equity may not respect this accounting
identity, and should be carefully compared. Generally speaking, a
high ratio may indicate that the company is much resourced with
(outside) borrowing as compared to funding from shareholders.
 Debt to total assets ratio

The debt to total assets ratio is an indicator of financial leverage. It

tells you the percentage of total assets that were financed by
creditors, liabilities, debt.

The debt to total assets ratio is calculated by dividing a corporation’s

total liabilities by its total assets. Let’s assume that a corporation has
$100 million in assets, $40 million in liabilities, and $60 million in
stockholder’s equity. Its debt to total assets ratio will be 0.4 ($40
million of liabilities dividend by $100 million of assets), or 0.4 to 1. In
this example, the debt to total assets ratio tells you that 40% of the
corporation’s assets are financed by the creditors or debt (and
therefore 60% is financed by the owners). A higher percentage
indicates more leverage and more risk.

Another ratio, the debt to equity ratio, is often used instead of the
debt to total assets ratio. The debt to equity ratio uses the same
inputs but provides a different view. Using the information above,
the debt to equity ratio will be .67 to 1 ($40 million of liabilities
divided by $60 million of stockholders equity).
 Proprietary ratio

The proprietary ratio (also known as the equity ratio) is the

proportion of shareholders equity to total assets, and as such
provides a rough estimate of the amount of capitalization currently
used to support a business. If the ratio is high, this indicates that a
company has a sufficient amount of equity to support the functions
of the business, and probably has room in its financial structure to
take on additional debt, if necessary. Conversely, a low ratio
indicates that a business may be making use of too much debt or
trade payables, rather than equity, to support operations (which may
place the company at risk of bankruptcy).

Thus, the equity ratio is a general indicator of financial stability. It

should be used in conjunction with the net profit ratio and an
examination of the statement of cash flows to gain a better overview
of the financial circumstances of a business. These additional
measures reveal the ability of a business to earn a profit and
generate cash flows, respectively.

To calculate the proprietary ratio, divide total shareholders equity by

total assets. The results will be more representative of the
company’s true situation if you exclude goodwill and intangible
assets. From the denominator. The more restrictive version of the
formula is

Shareholders’ equity ÷ total tangible assets.

 Interest Coverage Ratio

The interest coverage ratio is a debt ratio and profitability ratio used
to determine how easily a company can pay interest on its
outstanding debt. The interest coverage ratio may be calculated by
dividing a company’s earnings before interest and taxes (EBIT) during
a given period by the company’s interest payments due within the
same period.

The method for calculating interest coverage ratio may be

represented with the following formula:

Interest Coverage Ratio = EBIT ÷ Interest Expense

Interest coverage ratio is also called “times interest earned”.

Essentially, the interest coverage ratio measures how many times

over a company could pay its current interest payment with its
available earnings. In other words, it measures the margin of safety
a company has for paying interest during a given period, which a
company needs in order to survive future (and perhaps
unforeseeable) any financial hardship that may arise. A company’s
ability to meet its interest obligations is an aspect off a company’s
solvency, and is thus a very important factor in the return for
shareholders.

To provide an example of how to calculate interest coverage interest

coverage ratio, suppose that a company’s earnings during a given
quarter are $625000 and that it has debts upon which it is liable for
payments of $30,000 every month. To calculate the interest
coverage ratio here, one would need to convert the monthly interest
payments into quarterly payments by multiplying them by three.
 Inventory Turnover ratio

The inventory turnover ratio is an efficiency ratio that shows how

effectively inventory is managed by comparing cost of goods sold
with average inventory for a period. This measures how many times
average inventory is “turned” or sold during a period. In other words,
it measures how many times a company sold its total average
inventory dollar amount during the year. A company with $1,000 of
average inventory and sales of $10,000 effectively sold its 10 times
over.

This ratio is important because total turnover depends on two main

components of performance. The first component is stock
purchasing. If larger amounts of inventory are purchased during the
year, the company will have to sell greater amounts of inventory to
improve its turnover. If the company can’t sell these greater
amounts of inventory, it will incur storage costs and other holding
costs.

The second component is sales. Sales have to match inventory

purchases otherwise the inventory will not turn effectively. That’s
why the purchasing and sales departments must be in tune with each
other.

The inventory turnover ratio is calculated by dividing the cost of

goods sold for a period by the average inventory for that period.
Average inventory is used instead of ending inventory because many
companies’ merchandise fluctuates greatly throughout the year. For
instance, a company might purchase a large quantity of merchandise
January 1 and sell that for the rest of the year. By December almost
the entire inventory is sold and the ending balance does not
accurately reflect the company’s actual inventory during the year.
Average inventory is usually calculated by adding the beginning and
ending inventory and dividing by two.

The cost of goods sold is reported on the income statement.

 Trade Receivables Ratio

The receivables turnover ratio is an accounting measure used to

quantify a firm's effectiveness in extending credit and in collecting
debts on that credit. The receivables turnover ratio is an account
ratio measuring how efficiently a firm uses its assets.

Receivables turnover ratio can be calculated by dividing the net value

of credit sales during a given period by the average accounts
receviables during the same period. Average accounts receivable can
be calculated by adding the value of accounts receivable at the
beginning of the desired period to their value at the end of the
period and dividing the sum by two.

The method for calculating receivables turnover ratio can be

represented with the following formula:

The receivables turnover ratio is most often calculated on an annual

basis, though it can also be calculated on a quarterly or monthly
basis.

Receivable turnover ratio is also often called accounts receivable

turnover, the accounts receivable turnover ratio, or the debtor’s
turnover ratio.
 Trade payables ratio

The accounts payable turnover ratio is a short-term liquidity measure

used to quantify the rate at which a company pays off its suppliers.
Accounts payable turnover ratio is calculated by taking the total
purchases made from suppliers, or cost of sales, and dividing it by
the average accounts payable amount during the same period.

The measure shows investors how many times per period the
company pays its accounts payable. Accounts payable, also known as
payables, represents short-term debt obligations listed under the
balance sheet's current liabilities. Accounts payable is not exclusive
to businesses; it also extends to individuals with short-term debt
obligations, such as credit card payments.

A decreasing turnover ratio indicates that a company is taking longer

to pay off its suppliers than in previous periods. When the turnover
ratio is increasing, the company is paying off suppliers at a faster rate
than in previous periods. The rate at which a company pays its debts
could indicate the financial condition of the firm. A decreasing ratio
could signal that a company is in financial distress; alternatively, it
could reflect that the company has negotiated different payment
arrangements with its suppliers.
 Working Capital Turnover Ratio

A working capital turnover ratio, also referred to as “net sales over

working capital”, or the net sales divided by working capital, is an
indication of a company’s effectiveness in using working capital.

Working capital is defined as the total amount of current assets

minus the total amount of current liabilities. You should use the
average amount of working capital for the 12-month period used to
calculate net sales. With most financial ratios, you should compare
working capital turnover ratio to other companies in the same
industry because every industry has different business fundamentals.

You can use the working capital turnover ratio to figure out the net
annual sales generated by the average amount of working capital
during a 12-month period. For example, if a company sold $5 million
worth of products and services, and it had a million dollars in
working capital, the company’s working capital turnover ratio would
be five because it’s five million dollars ($5,000,000) in net annual
sales divided by one million ($1,000,000).
 Gross Profit Ratio

Gross profit ratio (GP ratio) is a profitability ratio that shows the
relationship between gross profit and total net sales revenue. It is a
popular tool to evaluate the operational performance of the business
. The ratio is computed by dividing the gross profit figure by net
sales.

The following formula/equation is used to compute gross profit ratio:

When gross profit ratio is expressed in percentage form, it is known

as gross profit margin or gross profit percentage. The formula of
gross profit margin or percentage is given below:

The basic components of the formula of gross profit ratio (GP

ratio) are gross profit and net sales. Gross profit is equal to net sales
minus cost of goods sold. Net sales are equal to total gross sales less
returns inwards and discount allowed. The information about gross
profit and net sales is normally available from income statement of
the company.

Gross profit is very important for any business. It should be sufficient

to cover all expenses and provide for profit.

There is no norm or standard to interpret gross profit ratio (GP ratio).

Generally, a higher ratio is considered better.
The ratio can be used to test the business condition by comparing it
with past years’ ratio and with the ratio of other companies in the
industry. A consistent improvement in gross profit ratio over the
past years is the indication of continuous improvement . When the
ratio is compared with that of others in the industry, the analyst
must see whether they use the same accounting systems and
practices.
 Operating Ratio

In finance, the Operating ratio is a company's operating expenses as

a percentage of revenue. This financial ratio is most commonly used
for industries which require a large percentage of revenues to
maintain operations, such as railroads. In railroading, an operating
ratio of 80 or lower is considered desirable.

The operating ratio can be used to determine the efficiency of a

company's management by comparing operating expenses to net
sales. It is calculated by dividing the operating expenses by the net
sales. The smaller the ratio, the greater the organization's ability to
generate profit The ratio does not factor in expansion or debt
repayment.

Alternatively, it may be expressed as a ratio of sales to cost. In such

case a higher ratio indicates a better ability to generate revenue.

Investment analysts have many ways of analyzing company

performance. Because it concentrates on core business activities,
one of the most popular ways to analyze performance is by
evaluating the operating ratio. Along with return on assets and
return on equity, it is often used to measure a
company's operational efficiency. It is useful to track the operating
ratio over a period of time to identify trends in operational efficiency
or inefficiency. An operating ratio that is going up is viewed as a
negative sign, as this indicates that operating expenses are growing
larger or net sales are growing smaller. In this case, a company may
need to implement cost controls for margin improvement. An
operating ratio that is decreasing is viewed as a positive sign, as it
indicates that operating expenses are becoming an increasingly a
smaller percentage of net sales.
 Operating Profit Ratio

Operating Profit Margin is a profitability, or performance, ratio used

to calculate the percentage of profit a company produces from its
operations, prior to subtracting taxes and interest charges. It is
calculated by dividing the operating profit by total revenue, and
expressed as a percentage. The margin is also known as EBIT
(Earnings Before Interest and Tax) Margin.

Operating Profit Margin often differs across companies and

industries and is often used as a metric for benchmarking one
company against similar companies within the same industry. It can
reveal the top performers within an industry and indicate the need
for further research regarding why a particular company is
outperforming, or falling behind, its peers.

Operating profit is calculated by subtracting all COGS, depreciation

and amortization and all relevant operating expenses from total
revenues. Operating expenses include a company’s expenses beyond
direct production costs – such things as salaries and benefits, rent
and related overhead expenses, research and development costs,
etc. The operating profit margin calculation is a percentage of
operating profit derived from total revenue. For example, a 15%
operating profit margin is equal to $0.15 operating profit for every
$1 of revenue.

Operating Profit Margin differs from Net Profit Margin as a measure

of a company’s ability to be profitable. The difference is that the
former is based solely on its operations by excluding the financing
cost of interest payments and taxes.

An example of how this profit metric can be used is the situation of

an acquirer considering a leveraged buyout. When the acquirer is
analyzing the target company, they would be looking at the potential
improvements that they can bring into the operations. The operating
profit margin provides an insight into how well the target company
performs in comparison to its peers, in particular, how efficiently a
company manages its expenses so as to maximize profitability. The
omission of interest and taxes is helpful because a leveraged buyout
would inject a company with new debt, which would then make
historical interest expense irrelevant.

A company’s operating margin is indicative of how well it is managed

because operating expenses such as salaries, rent, and equipment
leases are variable, rather than fixed, expenses. A company may have
little control over direct production costs such as the cost of raw
materials required to produce the company’s products, but the
company’s management has a great deal of discretion in areas such
as how much they choose to spend on office rent, equipment, and
staffing. Therefore, a company’s operating margin is usually seen as a
superior indicator of the strength of a company’s management team,
as compared to gross or net profit margin.
 Net Profit Ratio

Net profit ratio (NP ratio) is a popular profitability ratio that shows
relationship between net profit after tax and net sales. It is
computed by dividing the net profit (after tax) by net sales.

Formula:

For the purpose of this ratio, net profit is equal to gross profit minus
operating expenses and income tax. All non-operating revenues and
expenses are not taken into account because the purpose of this
ratio is to evaluate the profitability of the business from its primary
operations. Examples of non-operating revenues include interest on
investments and income from sale of fixed assets. Examples of non-
operating expenses include interest on loan and loss on sale of
assets.

The relationship between net profit and net sales may also be
expressed in percentage form. When it is shown in percentage form,
it is known as net profit margin. The formula of net profit margin is
written as follows:

Net profit (NP) ratio is a useful tool to measure the overall

profitability of the business. A high ratio indicates the efficient
management of the affairs of business.
There is no norm to interpret this ratio. To see whether the business
is constantly improving its profitability or not, the analyst should
compare the ratio with the previous years’ ratio, the industry’s
average and the budgeted net profit ratio.

The use of net profit ratio in conjunction with the assets turnover
ratio helps in ascertaining how profitably the assets have been used
during the period.
Return on Capital Employed “OR” Return
on Investment

Return on Investment (ROI) is a performance measure, used to

evaluate the efficiency of an investment or compare the efficiency of
a number of different investments. ROI measures the amount
of return on an investment, relative to the investment’s cost. To
calculate ROI, the benefit (or return) of an investment is divided by
the cost of the investment. The result is expressed as a percentage or
a ratio.

The return on investment formula:

ROI = (Gain from Investment - Cost of Investment) / Cost of

Investment

In the above formula, "Gain from Investment” refers to the proceeds

obtained from the sale of the investment of interest. Because ROI is
measured as a percentage, it can be easily compared with returns
from other investments, allowing one to measure a variety of types
of investments against one another.

ROI is a popular metric because of its versatility and simplicity.

Essentially, ROI can be used as a rudimentary gauge of an
investment’s profitability. The calculation is not complicated,
relatively easy to interpret, and has a range of applications. If an
investment’s ROI is not positive, or if other opportunities with higher
ROIs are available, these signals can help investors eliminate or
select the best options.

Recently, certain investors and businesses have taken an interest in

the development of a new form of the ROI metric, called "Social
Return on Investment" or SROI. SROI was initially developed in the
early 2000s and takes into account broader impacts of projects using
extra-financial value (i.e. social and environmental metrics not
currently reflected in conventional financial accounts).