Financial Ratios Flashcards
What are Financial Ratios?
Ratios are the relationship of one number to another number.
Ratios are tools that help to interpret financial statements.
Ratios are used for financial analysis, including:
Evaluating trends over time (comparing one year to another year).
Comparing to industry averages (how the company did compared to the industry as a whole).
Comparing to general guidelines (how the company did compared to standards).
They’re helpful because absolute numbers in financial statements don’t necessarily tell the whole story.
Who uses Ratios?
Shareholders (potential and current), to make investment decisions.
Bankers and other lenders, to make lending decisions.
Management, to analyze business health.
Credit managers and other suppliers, to assess creditworthiness.
Potential customers, to determine the reliability of the company.
What are the types of Ratios?
Profitability, providing an in-depth understanding of the organization’s ability to generate profits.
Leverage, providing an in-depth understanding of the organization’s use of debt.
Liquidity, providing an in-depth understanding of the organization’s ability to pay its debts.
Efficiency, providing an in-depth understanding of the operations of the organization.
Gross Profit Margin (% of Revenue)
Profitability Ratio - Income Statement
Gross profit margin percentage, often called gross margin, is simply gross profit divided by revenue, with the result expressed as a percentage
Gross margin shows the basic profitability of the product itself, before expenses and overhead are added in.
It tells you how much of every sales dollar you get to use in the business and how much you you must pay out in direct costs (COGS or COS), just to get the product produced or the service delivered
Operating Profit (Income) Margin (% of Revenue)
Profitability Ratio - Income Statement
Operating profit margin, or operating margin, is a more comprehensive measure of a company’s ability to generate profit.
Operating profit or EBIT, is gross profit minus operating expenses, so the level of operating profit indicates how well a company is running its entire business from an operational standpoint
Operating margin is just operating profit divided by revenue, with the result expressed as a percentage
Net Profit Margin (%)
Profitability Ratio - Income Statement
Net profit margin, or net margin, tells a company how much out of every sales dollar it gets to keep after evreything else has been paid for - people, vendors, lenders, the government, and so on
its also known as return on sales, or ROS
Its just net profit divided by revenue, expressed as a percentage
net margin is a bottom-line ratio; but highly variable from one industry to another
Return of Assets (ROA)
Profitability Ratio
Tells you what percentage of every dollar invested in the business was returned to you as a profit; simply shows how effective the company is at using those assets to generate profit
formula is simply: net profit divided by total assets
Return on Equity (ROE)
Profitability Ratio
ROE tells you what percentage of profit we make for every dollar of equity invested in the company. Remember the difference between assets and equity: assets refers to what the company owns, and equity refers to its net worth as determined by accounting rules
Formula: net profit divided by shareholders equity
it is a good indicator of whether a company is even capable of generating a return that is worth whatever risk the investment may entail
Debt to Equity Ratio
Leverage Ratio
The debt-to-equity ratio is simple and straightforward: it tells how much debt the company has for every dollar of shareholder equity
Formula: total liabilities divided by shareholders equity (both come from balance sheet
a good debt-to-equity ratio depends on the industry
knowing the debt-to-equity ratio and how it compares with those of competitors is a handy gauge of how senior management is likely to feel about taking on more debt
Current Ratio (also called Working Capital Ratio)
Liquidity Ratio
current ratio measures a company’s current assets against its current liabilities (current in accounting generally means periods of less than a year)
Formula: current assets divided by current liabilities
In most industries, a current ratio is too low when it is getting close to 1.
Days out Standing (DSO)
Efficiency Ratio
Also known as average collection period and receivable days. It is the measure of the average time it takes to collect the cash from sales (how fast customers pay their bills)
Formula: ending A/R divided by revenue per day - just the annual sales figure - divided by 360
its an avenue for rapid improvement in a company’s cash position
Days in Inventory (DII)
Efficiency Ratio
measures the number of days inventory stays in the system
the numerator is average inventory (which is just beginning inventory plus ending inventory) divided by 2, then divided by COGS per day divided by 360
- Next step is calc inventory turns i.e. how many times inventory turns over in a year
The lower the inventory days the tighter your management of inventory and the better your cash position
Days Payable Outstanding (DPO)
Efficiency Ratio
Days payable outstanding ratio shows the average number of days it takes a company to pay its own outstanding invoices
Formula: ending accounts payable divided by COGS per day
Total Asset Turnover
Efficiency Ratio
total asset turnover compares revenue with total assets, not just fixed assets (total assets, includes cash, receivables, and inventory as well as PPE and other long-term assets.
Formula: revenue divided by total assets
What is Revenue Growth?
Total revenue growth is how much revenue has grown, as a percent, from one year to the next.
The formula to calculate revenue growth is:
