Financial Ratios cheat sheet

What is Ratio Analysis?

• Quantitative Analysis Tool: Ratio analysis is a quantitative method used to evaluate various aspects of a company's operating and financial performance such as its efficiency, liquidity, profitability, and solvency.
• Financial Statement Insights: It involves calculating ratios from the financial statements (balance sheet, income statement, and cash flow statement) to gain insights into a company's financial health.
• Decision-Making Support: Provides valuable information to management, investors, and creditors to aid in making informed business, investment, and lending decisions.
• Comparative Assessment: Enables comparison over different periods for the same company (time-series analysis) or comparison with other companies in the same industry (cross-sectional analysis).
• Performance Indicators: Serves as indicators of a company's performance trends and potential issues, guiding strategic planning and corrective actions.

Why use Ratios

• Assess Financial Health: Ratios provide a quick snapshot of a company's financial condition, helping to assess its liquidity, profitability, and solvency.
• Benchmarking: They enable comparisons with industry averages and peers, identifying strengths and weaknesses relative to competitors.
• Trend Analysis: Tracking ratios over time can highlight trends, offering insights into improving or declining financial performance.
• Investment Decisions: Ratios help investors evaluate the attractiveness of a company as an investment by analyzing its earnings potential and risk level.
• Operational Efficiency: They can reveal areas of operational strength and pinpoint opportunities for cost reduction and efficiency improvements.

Type of Ratios

1. Profitability ratios measure the company's ability to generate earnings relative to its revenue, assets, equity, and other financial metrics.
2. Leverage ratios measure the degree to which a company uses borrowed funds.
3. Efficiency ratios measure how well a company uses its assets and liabilities to generate sales and maximize profits.
4. Liquidity ratios measure a company's ability to meet its short-term obligations with its most liquid assets.
5. Valuation ratios are used to assess a company's financial performance in relation to its market value, offering insights into how investors view the company's growth prospects and profitability.

Return on Equity (ROE)

• Formula: Net Income / Shareholders' Equity
• Purpose: Measures the company's profitability by revealing how much profit a company generates with the money shareholders have invested.
• Example: If a company has a net income of $20 million and shareholders' equity of $100 million, the ROE is 20%.

Return on Assets (ROA)

• Formula: Net Income / Total Assets
• Purpose: Indicates how efficiently a company's management is using its assets to generate earnings.
• Example: With a net income of $10 million and total assets of $50 million, the ROA is 20%.

Return on Capital Employed (ROCE)

• Formula: EBIT / (Total Assets - Current Liabilities)
• Purpose: Measures a company's efficiency and profitability of its capital investments.
• Example: An EBIT of $15 million and capital employed of $75 million yields a ROCE of 20%.

Gross Margin Ratio

• Formula: (Revenue - Cost of Goods Sold) / Revenue
• Purpose: Shows the proportion of money left over from revenues after accounting for the cost of goods sold.
• Example: Revenue of $100 million and COGS of $60 million result in a gross margin ratio of 40%.

Operating Profit Margin

• Formula: Operating Income / Revenue
• Purpose: Indicates how much profit a company makes after paying for variable costs of production before paying interest or tax.
• Example: Operating income of $20 million on $100 million revenue results in an operating profit margin of 20%.

Net Profit Margin

• Formula: Net Income / Revenue
• Purpose: Shows the amount of each dollar of revenue that the company retains as net profit.
• Example: A net income of $5 million on revenue of $50 million gives a net profit margin of 10%.

Debt to Equity Ratio

• Formula: Total Liabilities / Shareholders' Equity
• Purpose: Indicates what proportion of equity and debt the company is using to finance its assets.
• Example: Total liabilities of $10 million and shareholders' equity of $20 million result in a debt to equity ratio of 0.5.

Equity Ratio

• Formula: Shareholders' Equity / Total Assets
• Purpose: Measures the proportion of a company's total assets that are financed by shareholders' equity.
• Example: Shareholders' equity of $30 million and total assets of $60 million give an equity ratio of 50%.

Debt Ratio

• Formula: Total Liabilities / Total Assets
• Purpose: Indicates the proportion of a company's assets that are financed through debt.
• Example: Total liabilities of $40 million and total assets of $100 million result in a debt ratio of 40%.

Accounts Receivable Turnover Ratio

• Formula: Net Credit Sales / Average Accounts Receivable
• Purpose: Measures how efficiently a company collects debt from its credit sales.
• Example: Net credit sales of $100 million and average accounts receivable of $10 million result in an accounts receivable turnover ratio of 10 times.

Accounts Receivable Days

• Formula: 365 / Accounts Receivable Turnover Ratio
• Purpose: Indicates the average number of days it takes for a company to collect payments from its credit sales.
• Example: With an accounts receivable turnover ratio of 10, the accounts receivable days are 36.5.

Asset Turnover Ratio

• Formula: Net Sales / Average Total Assets
• Purpose: Measures how efficiently a company uses its assets to generate sales.
• Example: Net sales of $200 million and average total assets of $100 million result in an asset turnover ratio of 2.

Inventory Turnover Ratio

• Formula: Cost of Goods Sold / Average Inventory
• Purpose: Shows how quickly a company sells and replaces its inventory over a period.
• Example: COGS of $90 million and average inventory of $15 million result in an inventory turnover ratio of 6 times.

Inventory Days

• Formula: 365 / Inventory Turnover Ratio
• Purpose: Indicates the average number of days

Certainly! Let's continue with the Liquidity Ratios section, providing the "Purpose" and "Example" for each ratio.

Current Ratio

• Formula: Current Assets / Current Liabilities
• Purpose: Assesses a company's ability to pay off its short-term liabilities with its short-term assets. A higher ratio indicates better liquidity.
• Example: If current assets are $200,000 and current liabilities are $100,000, the current ratio is 2.0, indicating sufficient liquidity to cover short-term obligations twice over.

Quick Ratio

• Formula: (Current Assets - Inventory) / Current Liabilities
• Purpose: Provides a more stringent measure of liquidity than the current ratio by excluding inventory, which is not as easily convertible to cash.
• Example: With current assets of $200,000, inventory of $50,000, and current liabilities of $100,000, the quick ratio is 1.5, suggesting good liquidity but factoring out less liquid inventory.

Cash Ratio

• Formula: (Cash and Cash Equivalents) / Current Liabilities
• Purpose: Measures the ability of a company to pay off its short-term liabilities with only its cash and cash equivalents, offering the most conservative view of liquidity.
• Example: If cash and cash equivalents are $80,000 and current liabilities are $100,000, the cash ratio is 0.8, indicating reliance on cash reserves to cover most short-term obligations.

Defensive Interval Ratio

• Formula: (Cash + Marketable Securities + Receivables) / Daily Operational Expenses
• Purpose: Estimates how many days a company can continue to operate without needing to access additional funding or sales.
• Example: With cash, marketable securities, and receivables totaling $120,000, and daily operational expenses of $1,000, the DIR is 120 days, suggesting solid short-term financial stability.

Times Interest Earned Ratio

• Formula: EBIT / Interest Expense
• Purpose: Assesses a company's ability to cover its interest expenses with its earnings before interest and taxes (EBIT). A higher ratio indicates more comfortable coverage.
• Example: If EBIT is $50,000 and interest expense is $10,000, the TIE ratio is 5, showing that the company can cover its interest expenses 5 times over with its operating income.

Times Interest Earned (Cash Basis) Ratio

• Formula: (Operating Cash Flow + Interest Paid + Taxes Paid) / Interest Paid
• Purpose: Measures the ability to cover interest payments with cash flow from operations, offering a cash-focused perspective on interest coverage.
• Example: With operating cash flow of $70,000, interest paid of $10,000, and taxes paid of $15,000, the TIE (Cash Basis) ratio is 8.5, indicating strong coverage of interest by operational cash flows.

CAPEX to Operating Cash Ratio

• Formula: CAPEX / Operating Cash Flow
• Purpose: Evaluates how much of the company's operating cash flow is being used for capital expenditures, providing insight into the company's investment in long-term assets versus available cash.
• Example: If CAPEX is $40,000 and operating cash flow is $100,000, the ratio is 0.4, indicating 40% of operating cash is invested in capital assets.

Operating Cash Flow Ratio

• Formula: Operating Cash Flow / Current Liabilities
• Purpose: Measures the adequacy of a company's operating cash flow in covering its short-term liabilities, indicating operational liquidity.
• Example: With operating cash flow of $100,000 and current liabilities of $50,000, the ratio is 2, demonstrating strong operational liquidity with the ability to cover short-term liabilities twice over.

Price-to-Earnings (P/E) Ratio

• Formula: Market Value per Share / Earnings per Share (EPS)
• Purpose: Measures the market's valuation of a company relative to its earnings. A higher P/E ratio may indicate expectations of higher future growth.
• Example: If the market value per share is $50 and the EPS is $5, the P/E ratio is 10. This means investors are willing to pay $10 for every $1 of earnings.

EV/EBITDA Ratio

• Formula: Enterprise Value / EBITDA
• Purpose: Compares a company's total valuation to its earnings before interest, taxes, depreciation, and amortization. It provides a valuation metric that is less influenced by accounting practices and capital structure.
• Example: With an enterprise value of $200 million and EBITDA of $25 million, the EV/EBITDA ratio is 8, suggesting the company is valued at 8 times its EBITDA.

EV/EBIT Ratio

• Formula: Enterprise Value / EBIT
• Purpose: Similar to EV/EBITDA but includes the effects of depreciation and amortization, offering insight into how the market values the company's operating performance after accounting for these non-cash expenses.
• Example: If the enterprise value is $300 million and EBIT is $30 million, the EV/EBIT ratio is 10, indicating the company's enterprise value is 10 times its operating earnings.

EV/Revenue Ratio

• Formula: Enterprise Value / Revenue
• Purpose: Measures a company's total valuation relative to its revenue, providing a perspective on how the market values the company's sales. Useful for comparing companies that may not yet be profitable.
• Example: With an enterprise value of $500 million and revenue of $100 million, the EV/Revenue ratio is 5, indicating the company is valued at 5 times its revenue.