Profitability Ratios:

IF it's good ratios so attractive for investors to be acquired

1) % Return on Equity = Net Income /Average Stockholders’ Equity

It pinpoints a company's competitive advantage or lack of it. as an investor, it determines
how attractive an investment is. It's the overall profitability measure of success to owners
and investors as essential ratio for attractiveness of investment evaluating the result of
asset efficiency and financial leverage. It measures the profit percentage related to the
equity invested. this ratio tells how the company utilizes its assets to produce profit &
value to shareholders.
Healthy result: High
Result analysis: the ratio should go high. if the ratio goes lower, this means that the firm
is using more debt to finance its operations. this means that paying more interest
expenses which decrease the net income.
Recommendations: if the result is relatively low, we recommend that the firm should
change its financial strategy to be more dependent on equity rather than debt. also, it
should change its marketing strategy to increase its sales in less operations cost to
increase its net income.
2) % Return on Assets = Net Income /Average Total Assets
Many analysts consider this ratio as the best overall measure of a company’s
profitability. After-tax profits per dollar of assets; this ratio is also called return on
investment (ROI). The higher ratio, the more productive and efficient the management in
utilizing resources.
Usage: It shows the return on assets percentage after interest and taxes.
Healthy result: High
Result analysis: the ratio should go high. if the ratio goes lower, this means that the firm
is not utilizing its assets in a proper way. also means that the firm is paying more interest
expenses which decrease the net income.
Related Ratios: turnover ratios
Recommendations: if the result is relatively low, we recommend that the firm should
change its financial strategy to be more dependent on equity rather than debt. Also, it
should change its marketing strategy to increase its sales in less operations cost to
increase its net income.
3) Financial Leverage = Return on Equity - Return on Assets
Financial leverage is the advantage or disadvantage that occurs as the result of earning
a return on equity that is different from the return on assets. Positive number is good.
4) % Return on Capital Employed (ROCE) = EBIT /Capital Employed (Total Assets -
Current Liabilities)
It measures how efficiently a company is using its capital to generate profits. Higher is
favorable for investors but not enough without other profitability ratios.
5) Earnings per Share (EPS) = Net Income /Average Number of Shares Outstanding
for the Period
EPS compared to previous year. Earnings per share is probably the single most widely
watched financial ratio. If there are preferred dividends, the amount is subtracted from
net income
6) Quality of Income = Cash Flow from Operating Activities /Net Income
A ratio higher than 1 indicates high-quality earnings.
7) % Gross Profit Margin = Gross Margin /Net Sales
This ratio tells us the percentage of each sales dollar that is gross margin. High gross
margin is desired. But low gross profit may not be related to poor performance as the
 cost of production may be high as it depends on the industry itself e.g., legal services
office has higher gross profit margin than car production manufacture.
8) % Operating Profit Margin (EBIT Margin) = Operating Margin /Net Sales
This ratio tells us the percentage of each sales dollar that is operating margin i.e., % of
profit the company yield from its operations prior subtracting taxes and interest charges.
It measures to acquirer/investor how well the company operates in comparison with
peers & how efficiently it can manage expenses to maximize profit
9) % Net Profit Margin = Net Income /Net Sales
This ratio tells us the percentage of each sales dollar that is net income. It's industry
dependent that's related to net profit calculated by deducting all company expenses from
the total revenues.

Activity – Efficiency Ratios:

It measures how well the company is utilizing its assets & resources. Turnover ratios
measure how many times a business can finish a cycle of a certain metric within a specific
period of time. And manipulated to see how many days within a specific period of time it
takes for a business to complete a cycle for a specific metric.
1) Fixed Asset Turnover = Net Sales Revenue /Average Net Fixed Assets
This ratio measures a company’s ability to generate sales given an investment in fixed
assets. Sales productivity and plant and Fixed assets equipment utilization. if the result
is fair compared with the last years, indicating that the firm is using its fixed assets
intensively. If the result is less than the industry average this means that the firm doesn't
utilize its assets on a proper manner.
2) Total Asset Turnover = Net Sales Revenue /Average Total Assets
Measures how efficient a company uses its assets to generate sales as turnover of all
the firm's assets. Whether a firm is generating a sufficient volume of business for the
size of its asset investment. higher ratio is favorable as it indicates efficient use of
assets. conversely, a low ratio may indicate poor utilization of assets, poor collection
methods, or poor inventory management.
Recommendations: Sales should be increased, some assets should be sold, Apply both
solutions.
3) Accounts Receivable Turnover (Debtor's Turnover) = Net Credit Sales /Average
Accounts Receivables
This ratio measures how quickly a company collects its accounts receivable., the
number of times over a specific period of time that a company collects its average
accounts receivable. The higher the times is better.
4) Average Age of Receivables = Days in Year /Receivable Turnover
This ratio measures the average number of days it takes to collect receivables. i.e., the
number of days on average that it takes a company to collect on credit sales from its
customers. The shorter number of days is favorable for complete cycle.
5) Inventory Turnover = Cost of Goods Sold /Average Inventory
This ratio measures how many times a business sells and replaces its stock of goods in
a given period of time i.e., how efficient a business at clearing its inventories. Whether a
firm holds excessive stocks of inventories and whether a firm is selling its inventories
slowly compared to the previous year.
if the result is lower than the industry average, this suggest that the firm is holding too
much inventory. Excess inventory is unproductive, and it represents an investment with
a low or zero rate of return. The higher number of inventory turnover times, the better
Related Ratios:
Current ratio (Liquidity ratio)
 a low turnover, we must wonder whether the firm is actually holding obsolete goods not
worth there stated value.
6) Average Days’ Supply in Inventory = Days in Year /Inventory Turnover
This ratio measures the average number of days it takes to sell the entire inventory as a
measure of business efficiency. The shorter the days of inventory, the better.
7) Accounts Payable Turnover = Cost of Goods Sold /Average Accounts Payable
This ratio measures how quickly the company pays its accounts payable. The higher
number of accounts payables turnover times, the better.
8) Average Age of Payables = Days in Year /Accounts Payable Turnover
This ratio measures the average number of days it takes to pay its suppliers. The longer
the period for paying the accounts payables is better.
9) Cash Conversion Cycle or Net Trade Cycle = Average collection period + Days
inventory held - Days payable outstanding
Helps the analyst understand why cash flow generation has improved or deteriorated by
analyzing: Key balance sheet accounts that affect cash flow from operating activities:
Accounts Receivable, Inventory, Accounts Payable

Liquidity Ratios:
It evaluates the financial soundness of a company & used to determine the riskiness of a firm to decide
whether to extend credit to the firm.
1) Current Ratio = Current Assets /Current Liabilities
This ratio is a short-term indicator measures the ability of the company to pay current
debts as they become due from short term assets. It measures hoe the company can
maximize the liquidity of its current assets to settle its debt obligations. if the result is
less than previous year, this means that the firm has a great risk concerning its capability
to satisfy its obligations. A current ratio greater than 1 suggests financial wellbeing for
the company however too high rate suggests that the company is leaving too much
excess cash unused rather than investing the cash into projects for the company growth.
if the result is greater than Year before then: from creditor standpoint, they like to see a
high current ratio because if the firm getting into financial difficulty its liquidity position will
be relatively weak so, this ratio provides the best single indicator of the extent to which
the claims of short-term creditors are covered by assets that are expected to be
converted to cash fairly quickly. from shareholder standpoint, a high current ratio could
mean that the firm has a lot of money tied up in nonproductive assets
2) Quick Ratio (Acid Test) = Current Assets - Inventory /Current Liabilities
This ratio is like the current ratio but measures the company’s immediate ability to pay
current debts from current assets excluding inventories i.e., The extent to which a firm
can meet its short-term obligations without relying upon the sale of its inventories with
only assets that can quickly be converted to cash. A quick ratio greater than 1 suggests
financial wellbeing for the company as the company can repay its short-term obligations
with only its liquid assets however too high rate suggests that the company is leaving too
much excess cash unused rather than investing the cash into projects for the company
growth
if the result is less than year before, this means that the firm has a great risk concerning
its capabilities to satisfy its obligations. This means that if the accounts receivables can
be collected, the company can pay off its current liabilities without having to liquidate its
inventory.
3) Cash Ratio = Cash + Cash Equivalents /Current Liabilities
Much stricter & more conservative measure because of cash and cash equivalent usage
as the most liquid assets (cash equivalent as saving account, treasury bill and market
instruments). It measures the ability of company to pay the current obligations from cash
 or near cash assets. Creditors prefer a higher ratio as it indicates the company can pay
off its debts the ratio is preferred between 0.5 to 1 & too high ratio indicates that the
company is holding too much cash instead of utilization in projects generating returns or
growth.

Solvency Leverage Ratios:

Tests of solvency/ leverage measure a company’s ability to meet its long-term obligations. It indicates
how the company assets & business operations are financed using debts or equity & represent the
extent to which a business is utilizing borrowed money. If debt ratios is risky to creditors (company is
financed by debts) so financial policies for long term debts shall be revised to be more effective and
efficient
1) Debt-to-Equity Ratio = Total Liabilities /Stockholders’ Equity
This ratio compares whether the company capital structure utilizes more debt or equity
financing. it measures the amount of liabilities that exists for each $1 invested by the
owners. The percentage of total funds provided by creditors versus by owners. A higher
debt to equity ratio means that the company is levered that is financed by debts knowing
that leverage has benefits such as tax deduction on interest expenses but also the risk
associated with these expenses thus the leverage is preferable for companies with
stable cash flow but not for companies in decline. the ratio is industry dependent.
2) % Debt Ratio = Total Liabilities /Total Assets
Usage: To determine the overall risk of the company. Debt ratio describes how the firm
is financed, i.e it measures the percentage of funds provided by sources other than
equity & equity ratio determines the residual claim of shareholders on a business
determining what portion of business could be claimed by shareholders upon liquidation.
Healthy result: %The lower, the better and the higher the debt ratio, the greater the
degree of leverage and financial risk to invest in or lend to. if the % increases steadily it
may indicate a default at some point in the future. i.e., %100 means the company is
highly leveraged as liabilities as same as assets but more than 100% means the
company is extremely leveraged and highly risky to invest in or lend to as liabilities is
higher than assets.
Result analysis: for debt ratio, Creditors prefer low debt ratios because the lower the
ratio, the greater the cushion against creditors' losses in the event of liquidation. for
creditors, it help determine the amount of debt in a company, ability to repay its debts
and whether additional loans will be extended to the company. Stockholders, on the
other hand, may want more leverage because it magnifies expected earnings. for
investors, it helps make sure the company is solvent, have the ability to meet current
and future obligations and can generate return on their investment.
3) Times Interest Earned = EBIT /Interest Expense
This ratio indicates a margin of protection for creditors. Usage: It measures the ability of
the firm to pay interest, i.e. measures the extent to which operating income can be
decline before the firm is unable to meet its annual interest cost. Healthy result: Higher
times is better as it's safety margin for creditors Result analysis: Creditors prefer TIE
ratios to be high because the lower the ratio it means failure to meet obligations, thus
can bring legal action by the creditors, possibly resulting in bankruptcy. Related Ratios:
Profit Margin Ratio. if the result is low this might mean that the interest cost is high, while
the net income is calculated after deducting the interest expenses from gross income;
this means that the profit margin goes lower. Recommendations: if the result is relatively
high, this means that the firm can depend on more debt on financing its operations. if the
result is moderate, this means that the firm would face difficulties if it attempted to
borrow additional funds.
4) Cash Coverage = Cash Flow from Operating Activities Before Interest and Taxes
Paid /Interest Paid
This ratio compares the cash generated with the cash obligations of the period.
5) Capital Structure Ratio (CSR) = Long Term Liabilities /Capital (Long Term
Liabilities + Stockholders' Equity)

Market Ratios:
For exchange market registered companies only
1) Price/Earnings (P/E) Ratio = Current Market Price Per Share /Earnings Per Share
Market tests relate the current market price of a share of stock to an indicator of the
return that might accrue to the investor. This ratio measures the relationship between the
current market price of the stock and its earnings per share. This ratio the lower the
better for a new investor.
2) Dividend Yield = Dividends Per Share /Market Price Per Share
This ratio is often used to compare the dividend-paying performance of different
investment alternatives.