Business / Economics: Financial Ratios

Analyzing the financial information for a company provides insight into its financial operations. Often financial information is converted into ratios in order to provide a basis for comparison. Comparing one company’s financial ratios with those of other companies within its industry can provide an accurate picture of the company’s financial health.

When researching a company’s standing within its industry, it is helpful to know its SIC and/or NAICS industry codes. Many of the financial ratio resources are organized based on these codes.

Examples of some of the ratios you will encounter include:

CURRENT RATIO: Current Assets divided by Current Liabilities. This ratio reveals the protection afforded short-term creditors in cash or near-cash assets. It shows the number of dollars of liquid assets available to cover each dollar of current debt. The larger the ratio, the greater the liquidity. (From Industry Norms and Key Business Ratios)

QUICK RATIO: Cash plus Accounts Receivable divided by Current Liabilities. This ratio measures the degree to which current assets cover current liabilities. The higher the ratio, the more assurance exists that the retirement of current liabilities can be made. (From Industry Norms and Key Business Ratios)

INVENTORY TURNOVER: A measurement of the liquidity of inventory computed by dividing the Cost of Goods Sold by the Average Inventory. The result shows the number of times that the average inventory can be converted into receivables or cash. Typically, the higher the turnover rate, the more likely profits will be higher. (From Almanac of Business and Industrial Financial Ratios)

RECEIVABLES TURNOVER: Obtained by dividing Sales Average by Net Receivables. This ratio measures the liquidity of accounts receivable. It indicates the average collection period throughout the year. (From Almanac of Business and Industrial Financial Ratios)

RETURN ON ASSETS: Net Profit After Taxes divided by Total Assets. This ratio is the key indicator of profitability for a firm. It matches operating profits with the assets available to earn a return. Companies efficiently using their assets will have a relatively high return while less well-run businesses will be relatively low. (From Industry Norms and Key Business Ratios)

RETURN ON EQUITY: Net Profit After Taxes divided by Net Worth. This ratio is used to analyze the ability of the firm’s management to realize an adequate return on the capital invested by the owners of the firm. Generally, a relationship of at least 10% is regarded as a desirable objective for providing dividends plus funds for future growth. (From Industry Norms and Key Business Ratios)

OPERATING MARGIN: Net profit before taxes plus interest expense and depreciation, the result divided by net sales and multiplied by 100 to provide a percentage. (From 101 Business Ratios)

PRICE TO EARNINGS: Per share market price of company’s stock divided by net profit after taxes per share. (From 101 Business Ratios)

DIVIDEND YIELD: Dividends paid (annualized) divided by stockholders’ equity, multiplied by 100 to provide a percentage. (From 101 Business Ratios)

Explanation Summary borrowed from Christine Adams' Financial Ratios Research Guide