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Financial Ratios

Financial ratios are calculated to analyse management effectiveness in employing capital, and how solvent and profitable is the company. The information contained in the Income Statement and Balance Sheet is essential to obtain financial ratios.

Financial Ratios
LIQUIDITY Ratios
Description How to Calculate it What It Means
Current Ratio = (Current Assets) / (Current Liabilities) Shows the extent to which a firm can meet its short-term obligations.
Quick Ratio = (Current Assets minus Inventory) / (Current Liabilities) Indicates the extent to which a firm can meet its short-term obligations without relying upon the sale of its inventory.
Interest Coverage Ratio = Net Income Before Interest and Taxes and Depreciation (EBITDA) / Interest Payable Is a measure of a company’s ability to honor its debt payments. A lower interest coverage ratio means less earnings are available to meet interest payments and that the business is more vulnerable to increases in interest rates
Working Capital = (Current Assets) minus (Current Liabilities) Shows funds available after paying short term debts
EFFICIENCY Ratios
Description How to Calculate it What It Means
Asset Turnover Ratio = (Sales) / (Total Assets) Measures sales performance on capital employed including equipment, vehicles, buildings, and plant and equipment. Indicates the efficiency of asset use.
Debtors Days Ratio = (Debtors x 365) / (Sales) Informs on the average number of days in which debtors pay their outstanding obligations. The longer the period the more stressed the cash flow will be. In the case of our firm, BIS Ltd., debtors pay up within 30 days of receiving the goods.
Inventory Turn Ratio = (Cost of Goods Sold) / (Inventory) Measures the rotation of inventory in relation to total cost of goods sold. This rotation depends on the type of business and the level of sales. A grocery would turn more rapidly than a manufacturing firm. Also an economic recession would depress sales thus the cost of goods sold. But inventory levels may not be easily reduced and remain high, creating a slow rotation in the year. It usually implies financial problems ahead.
PROFITABILITY Ratios
Description How to Calculate it What It Means
Gross Profit Ratio = (Sales minus Cost of Goods) / (Sales) Shows how much is available, as a percentage of revenue, to pay for overheads, marketing, interest, taxes to obtain net income.
Net Profit Margin = (Sales minus All Costs) / (Sales) Shows net income in relation to sales, after direct costs and operating expenses are paid for.
Return on Assets Ratio (ROA) = (Net Income) / (Total Assets) Illustrates management skills in using assets to generate operating profits.
Return on Initial Capital (ROIC) - Percentage Growth of Initial Capital = Equity / Initial Capital Indicates percentage Growth of Initial Capital. Shows how the initial investment has performed during a given period. It is obtained by dividing equity in the period by initially invested capital when launching the firm.
Return on Equity Ratio (ROE) = Net Income / Equity Measures management ability in optimizing equity. It is done on a period by period basis comparing profit or loss with equity.
LEVERAGE Ratios
Description How to Calculate it What It Means
Debt-to-Asset Ratio = (Total Debt) / (Total Assets) Shows the proportion of funds provided by trade creditors and lenders in relation to total capital employed.
Debt-to-Equity Ratio = (Long Term Debt) / (Total Equity) Indicates the proportion between external debt and equity in a firm’s long-term capital structure.


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