Financial Ratios – Formulas and Explanations
Total Debt Debt-to-Asset
Compares total debt to total assets.
Total Assets Expresses what percentage of assets is being financed by debt vs. equity
The higher the number, the more risk is being assumed by lenders.
Total Debt Debt-to-Equity
Expresses how much of the business was financed by debt vs. owner investment.
Total Equity An acceptable range is 1:1 to 4:1 with most lenders looking for around 2:1.
Too much debt puts the business at risk, not enough may limit profitability.
Current Assets Current Ratio
Expresses the relationship between current assets and current liabilities.
Current Liabilities Measures your ability to pay current liabilities
Should be greater than 1:1; goal should be 2:1
Inventory Inventory to Net Working Capital
Measures what proportion of working capital is made up of inventory.
C Assets–C Liabilities If number is too high it could indicate a liquidity problem.
Expresses the relationship between current assets minus inventory and current liabilities.
Current Liabilities Measures your ability to pay current liabilities with liquid assets
Goal should be 1:1 – means you don’t need to sell inventory to meet current obligations
Accounts Receivable Turnover
Net Credit Sales
Measures number of times per year the receivable account revolves
Avg. Accts Receivable Expresses the liquidity of your receivables
The higher the number, the shorter the time between a sale and payment
Net Sales Measures how many sales dollars are generated by each dollar investment in assets
Total Assets Shows how efficiently your assets are being used.
Average Collection Period
365 x Avg. Accts Rec Indicates the number of days it takes to get paid
Net Credit Sales Compare to your industry
You may be too lenient in your collection procedures or payment terms
Average Days Payable
365 x Avg. Accts Pay Indicates the number of days it takes you to pay your bills
Net Credit Purchases Compare to supplier terms
If you stretch suppliers unreasonably, you may not be able to count on them in a pinch
365 x Avg. Inventory Days of Sale in Inventory
Indicates how many days you could go without purchasing any further inventory
COGS Too many indicates you have too much inventory
Too little means you are probably missing sales due to stock-outs
Fixed Asset Utilization
Net Sales Measures how many sales dollars are generated by each dollar investment in equipment,
Fixed Assets land and buildings
Shows how efficiently your investment in big ticket items is performing
COGS Measures how many times per year your inventory revolves
Average Inventory Too low indicates you have too much inventory
Too high means you are probably missing sales due to stock-outs
Compare to your industry averages
Total Annual Sales Sales per Employee
Measures effectiveness of the contribution of your staff to sales.
Avg. # of Employees
You can compare the average to each person’s sales as a form of evaluation
Net Income-Pref Div Earnings per Share
Indicates annual profit generated by each common share in a corporate structure
# Common Shares Can compare with various markets
Net Profit Margin
Net Profit Indicates how much is left after all expenses and taxes have been paid.
Net Total Sales Indicated as a percentage of sales
From every sales dollar, how much is left?
Profit-Tax-Interest Return on Shareholder Equity
Compares annual profit per share versus share price.
For a business owner it indicates how much his/her investment returns as a %
Net Profit Return on Total Assets
Compares total annual profit to total assets
Total Assets Measures efficiency of assets in producing income
Profit Before Int&Tax Debt Coverage Ratio
Measures how well your business covers debt and how easily it could handle more debt
Tot Bank Fees&Interest Very important to lenders