Financial Ratios
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Profitability Ratios
- Gross Profit Margin = Gross Profit / Sales
- Operating Profit Margin = Operating Profit / Sales
- Net Profit Margin = Net Profit / Sales
- Return on Assets (ROA) = Net Profit / Assets
- Return on Equity (ROE) = Net Profit / Shareholders Equity — much higher than ROA, the reason that companies use “financial leverage”
- Earnings per Share (EPS) = Net Income / Shares
- Price Earnings Ratio (PE) = (Price per Share) / (Earnings per Share)
- Market Capitalization = Shares * Price per Share
Financial Leverage Ratios
- Basics
- Financial Leverage “equals” Debt
- Debt used to grow profitability by creating more Assets
- Multiplies performance of owner’s investments (equity)
- Higher leverage means higher risk
- Debt-to-Equity = Total Liabilities / Equity
- Assets-to-Equity = Assets / Equity
Liquidity Ratios
Indicates if you can pay your bills.
- Current Ratio = Current Assets / Current Liabilities
- 2.0 is a nominal goal, lower than 1.0 is a concern.
- Ratio too high ⇒ over-conservative
- Quick Ratio = (Current Asset - Inventories) / Current Liabilities
- “Acid test” for inventory, assets that can be quickly turned into cash
- Expected to be at or above 1.0
Efficiency Ratios
How well are you managing the balance sheet? Fundamentally, how well are you managing your cash?
- Days-of-Inventory = Inventory / (COGS / 360)
- Inventory Turns = COGS / Inventory
- Receivable Days = Accounts Receivable / (Sales / 360)
- Payable Days = Payables / (COGS / 360)
Working Capital and Cash Conversion Cycles
- Working Capital = Current Assets - Current Liabilities
- Can’t go negative!
- Cash needed for short-term liabilities
- Working Capital Needed = Cash Conversion Cycle * Sales per day