SELECTED FINANCIAL RATIOS
Professor Ronen Israel
Interdisciplinary Center Herzliya (IDC), Israel
QUICK REFERENCE FOR FINANCIAL RATIOS
• Measuring Profitability - Profit Margins Gross Margin Percentage Operating Expenses Margin Operating Margin Return on Sales - Returns Return on Equity Return on Assets • Measuring Short-term Liquidity - Activity Asset Turnover Inventory Turnover Days Inventory Average Collection Period Average Payment Period - Solvency Current Ratio Quick Ratio or Acid-Test Ratio • Measuring Debt Burden - Leverage / Gearing Debt to Equity Debt to Assets Net Worth to Assets - Payment Coverage Times Interest Earned Fixed Charges Coverage • Market-Value Ratios - Price-Earning Ratio (P/E) - Dividend Yield - Market-to-Book Ratio
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MEASURING PROFITABILITY
Profit Margins
Ratio
Formula
Net Sales – Cost of Goods Sold Net Sales Operating Expenses Net Sales Earnings Before Interest and Taxes Net Sales Net Income Net Sales
Purpose
To measure percentage of sales available for other expenses and profit. To measure the cost efficiency of the firm. To measure the operating profitability of the firm. To measure the overall profitability of the firm.
Gross Margin Percentage
Operating Expenses Margin
Operating Margin
Return on Sales
Returns
Ratio
Formula
Net Income Previous Year Shareholders’ Equity
Purpose
To measure the annual percentage return to shareholders. To measure the operating earning power of the firm’s assets.
Return on Equity
Return on Assets
Earnings Before Interest and Taxes Previous Year Total Assets
3
MEASURING SHORT-TERM LIQUIDITY
Activity
Ratio
Formula
Net Sales Average Total Assets Cost of Goods Sold Average Inventory Average Inventory (Cost of Goods Sold/365)
Purpose
To measure the volume of sales generated by the firm’s assets in place. To measure how quickly the firm is selling its inventory. To measure how many production days inventory can support. To measure how quickly the firm is collecting receivables. To measure how long the firm is taking to pay suppliers.
Asset Turnover
Inventory Turnover
Days Inventory
Average Collection Period (Days Receivables Outstanding) Average Payment Period (Days Payables Outstanding)
Average Receivables (Sales/365) Average Payables (Purchases/365)
Solvency
Ratio
Current Ratio
Formula
Current Assets Current Liabilities
Purpose
To measure the current ability to meet short-term obligations. To measure the ability to meet short-term obligations with the most liquid assets.
Quick Ratio or Acid-Test Ratio
Cash + Receivables + Securities Current Liabilities
4
MEASURING DEBT BURDEN
Leverage / Gearing
Ratio
Debt to Equity
Formula
Total Debt Total Shareholders’ Equity
Purpose
To measure the extent to which the firm uses debt as a source of financing. To measure the extent to which the firm uses debt as a source of financing. To measure the extent to which the firm uses equity as a source of financing.
Debt to Assets
Total Debt Total Assets Net Worth Total Assets
Net Worth to Assets
Payment Coverage
Ratio
Coverage Ratio (Times Interest Earned) Fixed Charges Coverage
Formula
Purpose
Earnings before Interest and Taxes To measure the safety cushion Interest Expense to cover interest payments. EBIT + Lease Expense Interest + Lease Expense To measure the safety cushion to cover all fixed payments.
MARKET-VALUE RATIOS
Ratio
Price-Earning Ratio (P/E)
Formula
Stock Price Earnings per Share Dividend per share Stock Price Stock Price Book Value per Share
Purpose
To measure investors believes about growth opportunities. To measure the return to investors from dividends. Today’s value relative to what was invested in the past.
Dividend Yield
Market-to-Book Ratio
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