Ratios Calculations Interpretation

Main Liquidity Ratios

Current ratio Current Assets/Current Liabilities The current ratio measures a
company’s ability to pay off
short-term liabilities with
current assets

Quick ratio (Current Assets - Inventory)/Current The acid-test ratio measures a

Liabilities company’s ability to pay off
short-term liabilities with
quick assets:

Net working capital Current Assets - Current Liabilities It is a measure of a company’s

liquidity and its ability to meet
short-term obligations, as well
as fund operations of the
business. The ideal position is
to have more current assets
than current liabilities and thus
have a positive net working
capital balance.

Main leverage ratios

Debt to equity Total Debt/Shareholders' Equity The debt to equity
ratio calculates the weight of
total debt and financial
liabilities against shareholders’
equity. i.e. It is an indication
of the company's preference
for either debt or equity. A
debt to equity ratio greater
than 1 indicates that the
company is utilizing more debt
than equity to finance its
assets.

Debt to capital Total Debt/(Total Debt + Total Indicates how much of the
Equity) total capital (Financing) raised
by the company is made up of
debt.
Interest coverage EBIT/Interest Expense The interest coverage ratio is
used to determine how well a
company can pay the interest
on its outstanding debts. The
ICR is commonly used by
lenders, creditors, and
investors to determine the
riskiness of lending capital to a
company.

Main operating efficiency ratios

Inventory turnover Cost of Goods Sold/Average The inventory turnover ratio
Inventory tells us how many times
inventory is turned over within
the company's operating cycle
(usually a year).

Days in Inventory 365/Inventory Turnover Days in inventory is an

efficiency ratio that measures
the average number of days
the company holds its
inventory before selling it. The
ratio measures the number of
days funds are tied up in
inventory.

Receivables Turnover Net Credit Sales/Average Accounts The receivables turnover ratio
Receivable tells us how many times
receivables are collected
within the company's
operating cycle (usually a
year).

Accounts receivable days 365/Receivables Turnover Receivables Days is an

efficiency ratio that measures
the average number of days
the company takes to collect
its receivables.

Payables Turnover Ratio Net Credit Purchases/Average The accounts payable turnover
Accounts Payable ratio measures the average
number of times a company
pays its creditors within its
operating cycle (usually a
year).
Days Payable Outstanding 365/Accounts Payable Turnover Days Payable Outstanding
(DPO) refers to the average
number of days it takes a
company to pay back
its accounts payable.
Therefore, days payable
outstanding measures how
well a company is managing
its accounts payable.

Total asset turnover Sales/Average Total Assets The asset turnover ratio, also
known as the total asset
turnover ratio, measures the
efficiency with which a
company uses its assets to
produce sales.

A company with a high asset

turnover ratio operates more
efficiently as compared to
competitors with a lower ratio.

Main Profitability Ratios

Gross Margin Gross Profit/Net Sales The Gross Margin Ratio, also
known as the gross profit
margin ratio, is a profitability
ratio that compares the gross
margin of a company to
its revenue. It shows how
much profit a company makes
after paying off its Cost of
Goods Sold (COGS).

Operating Margin Ratio Operating Income/Net Sales Operating margin, also known
as return on sales, is an
important profitability ratio
measuring revenue after the
deduction of operating
expenses. It is calculated by
dividing operating income by
revenue. The operating margin
indicates how much of the
generated sales is left when all
operating expenses are paid
off.
Return on Assets Net Income/Total Assets Return on Assets (ROA) is a
type of return on investment
(ROI) metric that measures the
profitability of a business in
relation to its total assets. This
ratio indicates how well a
company is performing by
comparing the profit (net
income) it’s generating to the
capital it’s invested in
assets. The higher the return,
the more productive and
efficient management is in
utilizing economic resources.

Return on Equity Net Income/Shareholders' Equity Return on Equity is a two-part

ratio in its derivation because
it brings together the income
statement and the balance
sheet, where net income or
profit is compared to the
shareholders’ equity. The
number represents the total
return on equity capital and
shows the firm’s ability to turn
equity investments into profits.
To put it another way, it
measures the profits made for
each dollar from shareholders’
equity.