SELECTED FINANCIAL RATIOS Professor Ronen Israel Interdisciplinary Center Herzliya (IDC), Israel 2 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 3 MEASURING PROFITABILITY Profit Margins Ratio Formula Purpose Gross Margin Percentage Net Sales – Cost of Goods Sold Net Sales To measure percentage of sales available for other expenses and profit. Operating Expenses Margin Operating Expenses Net Sales To measure the cost efficiency of the firm. Operating Margin Earnings Before Interest and Taxes Net Sales To measure the operating profitability of the firm. Return on Sales Net Income Net Sales To measure the overall profitability of the firm. Returns Ratio Formula Purpose Return on Equity Net Income Previous Year Shareholders’ Equity To measure the annual percentage return to shareholders. Return on Assets Earnings Before Interest and Taxes Previous Year Total Assets To measure the operating earning power of the firm’s assets. 4 MEASURING SHORT-TERM LIQUIDITY Activity Ratio Formula Purpose Asset Turnover Net Sales Average Total Assets To measure the volume of sales generated by the firm’s assets in place. Inventory Turnover Cost of Goods Sold Average Inventory To measure how quickly the firm is selling its inventory. Days Inventory Average Inventory (Cost of Goods Sold/365) To measure how many production days inventory can support. Average Collection Period (Days Receivables Outstanding) Average Receivables (Sales/365) To measure how quickly the firm is collecting receivables. Average Payment Period (Days Payables Outstanding) Average Payables (Purchases/365) To measure how long the firm is taking to pay suppliers. Solvency Ratio Formula Purpose Current Ratio Current Assets Current Liabilities To measure the current ability to meet short-term obligations. Quick Ratio or Acid-Test Ratio Cash + Receivables + Securities Current Liabilities To measure the ability to meet short-term obligations with the most liquid assets. 5 MEASURING DEBT BURDEN Leverage /Gearing Ratio Formula Purpose Debt to Equity Total Debt Total Shareholders’ Equity To measure the extent to which the firm uses debt as a source of financing. Debt to Assets Total Debt Total Assets To measure the extent to which the firm uses debt as a source of financing. Net Worth to Assets Net Worth Total Assets To measure the extent to which the firm uses equity as a source of financing. Payment Coverage Ratio Formula Purpose Coverage Ratio (Times Interest Earned) Earnings before Interest and Taxes Interest Expense To measure the safety cushion to cover interest payments. Fixed Charges Coverage EBIT + Lease Expense Interest + Lease Expense To measure the safety cushion to cover all fixed payments. MARKET-VALUE RATIOS Ratio Formula Purpose Price-Earning Ratio (P/E) Stock Price Earnings per Share To measure investors believes about growth opportunities. Dividend Yield Dividend per share Stock Price To measure the return to investors from dividends. Market-to-Book Ratio Stock Price Book Value per Share Today’s value relative to what was invested in the past.