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Ratios

Accounting for Decision Making (James Cook University)

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Ratio Calculation
Profitability Ratios:

Return on Equity:

Return on Equity is a profitability ratio that shows how much profit each dollar of common stockholders’
equity generates.
A return on 1 means that every dollar of common stockholders’ equity generates 1 dollar of net income.
Higher ratios are almost always better than lower ratios, but have to be compared to other companies’
ratios in the industry.

Return on Assets:

Return on Assets (ROA) is a profitability ratio that measures how efficiently a company can manage its
assets to produce profits during a period.
Higher ratio shows that the company is more effectively managing its assets to produce greater amounts
of net income. A positive ROA ratio usually indicates an upward profit trend as well.

Profit Margin:

The Profit Margin Ratio is a profitability ratio that shows what percentage of sales are left over after all
expenses are paid by the business.
Higher ratio means higher income.

Gross Profit Margin:

Gross Profit
Gross Profit Margin=
Sales Revenue

Gross Profit Margin (GPM) is a profitability ratio that measures how efficiently a company uses its
materials and labour to produce and sell products profitably.

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Ratio Calculation

Cash Flow to Sales Ratio:

Cash Flow ¿ Sales Ratio=Cash flow ¿ operatingactivity

¿ sales
revenue

The Cash Flow to Sales Ratio reveals the ability of a business to generate cash flow in proportion to its
sales volume.

Asset Efficiency Ratio:

Asset Turnover Ratio:

The asset turnover ratio is an efficiency ratio that shows how efficiently a company can use its assets to
generate sales.
Higher ratio means the company is using its assets more efficiently. Lower ratios mean that the company
isn’t using its assets efficiently and most likely have management or production problems.

Inventory Turnover (days):

It indicates how many days the firm averagely needs to turn its inventory into sales.
(This company’s averagely needs to turn its inventory into sales is X days.)

Inventory Turnover (times):

InventoryTurnover (¿)= Cost of Sales

Average Inventory

It measures how many times a company sold its total average inventory dollar amount during the year.
(This company sold X times of its total average inventory dollar amount during the year.)
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Ratio Calculation

Receivables Turnover (days):

R eceivableTurnover (days)= AverageTrade Debtors( Average Account

Receivables)×365 Sales Revenue

It measures how many days per year averagely needed by a company to collect its receivables.
(This company needed X days per year averagely to collaboration with clients.)

Receivables Turnover (times):

Sales Revenue
ReceivableTurnover( ¿)=
AverageTradeDebtors( Average Account Receivables)

It measures how many times a business can collect its average accounts receivable during the year.
(This company can collect its average accounts receivables X times during the year.)

Days Debtors:

Debtor days is the average number of days required for a company to receive payment from its
customers for invoices issued to them. A larger number of debtor days means that a business must
invest more cash in its unpaid accounts’ receivable asset, while a smaller number implies that there is a
smaller investment in accounts receivable, and that therefore more cash is being made available for
other uses.

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Ratio Calculation

Liquidity Ratios:

Current Ratio:

The current ratio is a liquidity ratio that measures a firm’s ability to pay off its short-term liabilities with
its current assets.
The higher the ratio, the better it is for the company's creditors. It has the strongest ability to pay off its
short-term liabilities with its current assets.
Higher ratio shows the company can more easily make current debt payments.

Quick Asset Ratio:

The Quick Asset Ratio is a liquidity ratio that measures the ability of a company to pay its current
liabilities when they come due with only quick assets.
Higher ratio shows there are more quick assets than current liabilities. A company with a quick ratio of 1
indicates that quick assets equal current assets. This also shows that the company could pay off its
current liabilities without selling any long-term assets.

Cash Flow Ratio:

Cash Flow Ratio= NetCash Flows¿ Operating Activities ¿

Current Liabilities

Cash Flow Ratio measure the adequacy of a company’s cash generated from operating activities to pay
its current liabilities.
Higher ratio means better ability to withstand declined in operating performance, as well as a better
ability to pay dividends to investor.

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Ratio Calculation

Capital Structure Ratio:

Debt to Equity Ratio:

The debt to equity ratio is a liquidity ratio that compares a company’s total debt to total equity.
A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor
financing (shareholders).
A lower debt to equity ratio usually implies a more financially stable business.

Debt Ratio (to assets):

It shows what percentage of assets is funded by borrowing compared with the percentage of resources
that are funded by the investors.
Low ratio indicates that the bulk of asset funding is coming from equity. Lowest debt ratio means least
risky.

Equity Ratio:

Total Equity
Equity Ratio=
Total Assets

It measures the amount of assets that are financed by owners’ investments by comparing the total
equity in the company to the total assets.
A higher equity ratio or a higher contribution of shareholders to the capital indicates a company’s better
long-term solvency position.
A low equity ratio is easier for a business to sustain in an industry where sales and profits have minimal
volatility over time, but also includes higher risk to the creditors.

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Ratio Calculation

Interest Coverage Ratio:

The interest coverage ratio (ICR) is a financial ratio that measures a company’s ability to make interest
payments on its debt in a timely manner.
A high ratio indicates that a company can pay for its interest expense several times over, while a low
ratio is a strong indicator that a company may default on its loan payments.

Debt Coverage Ratio:

= NonCurrent Liabilities ¿ Debt Coverage

Ratio NetCash Flows¿ Operating Activities

It measures the ability of a revenue-producing property to pay for the cost of all related mortgage
payments.
A positive debt service ratio indicates that a property’s cash flows can cover all offsetting
loan payments.
A negative debt service coverage ratio indicates that the owner must contribute additional funds to pay
for the annual loan payments.

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