Financial Statements Analysis – Ratios

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Financial ratios are commonly used for financial statement analysis. These are mathematical indicators calculated to compare the financial position from year to year or company to company.

Direct comparison of financial statements is not as meaningful sometimes due to different size of relevant businesses for example. Financial ratios makes the financial statements analysis on a comparable level.

We categorised the financial ratios into the following groups and listed the most widely used formulas in each group to help us analyse the financial positions of companies:

I. Liquidity Analysis
II. Solvency Analysis
III. Coverage Analysis
IV. Profitability Analysis
V. Balance Sheet Analysis
VI. Shareholder Ratios
VII. Return Ratios

I. Liquidity Analysis

1) Current ratio
Measures the ability of a company to repay current liabilities with current assets

Current ratio = Current Assets / Current Liabilities

2) Quick ratio (also called Acid Test Ratio)
Measures the ability of a company to pay its debts by using its cash and near cash current assets

Quick ratio = (Cash + Marketable Securities + Receivables) / Current Liabilities

3) Cash ratio
An extreme liquidity ratio since only cash and cash equivalents are compared with the current liabilities

Cash ratio = Cash and Cash Equivalents / Current Liabilities

II. Solvency Ratio

4) Debt to Assets Ratio
Measures the debt level of a company as a percentage of its total assets

Debt to Assets Ratio = Total Debt / Total Assets

5) Debt to Equity Ratio
Measures the degree to which the assets of the company are financed by the debts and the shareholders’ equity of a business

Debt to Equity Ratio = Total Liabilities / Shareholders’ Equity

6) Debt to Capital Ratio
Measures the proportion of interest-bearing debt as a percentage of interest-bearing debt and shareholders’ equity

Debt to Capital Ratio = Total Debt / (Total Debt + Shareholders’ Equity)

III. Coverage Ratios

7) Interest Coverage Ratio
Measures the ability of a business to pay off its debts

Interest Coverage Ratio = EBIT / Interest Expenses

8) Fixed Charge Coverage Ratio
Measures whether earnings before interest, taxes and lease payments are sufficient to cover the interest and lease payments

Fixed Charge Coverage Ratio = (EBIT + Lease Payments excl. Interest) / (Lease Payment + Interest)

9) Equity Multiplier
Measures assets in pound per pound of equity. The higher the ratio the lower the financial leverage and the lower the ratio the higher the financial leverage

Equity Multiplier = Total Assets / Total Equity

IV. Profitability Analysis

10) Gross Margin
Measures what proportion of revenue is converted into gross profit

Gross Margin = Gross Profit / Total Revenue

11) Net Profit Margin
Measures the percentage of a company’s net income to its total revenue

Net Profit Margin = Net Income / Total Revenue

12) Operating Margin
Measures the percentage of a company’s operating income to its total revenue

Operating Margin = Operating Income / Total Revenue

13) EBITDA Margin
Measures the percentage of a company’s earnings before interest, tax, depreciation and amortisation to its total revenue

EBITDA Margin = EBITDA / Total Revenue

V. Balance Sheet Analysis

14) Days of Inventory
Measures the number of days a company takes to sell its average balance of inventory

Days of Inventory = (Average Inventory / COGS) x Number of Days

15) Inventory Turnover Ratio
Measures the number of times per period a company sells its entire inventories

Inventory Turnover Ratio = COGS / Average Inventory

16) Days Sales Outstanding (DSO or Days of Receivables)
Measure the average number of days a company takes to collect its receivables

DSO = (Accounts Receivables / Sales) x Number of Days

Or

DSO = Number of Days / Accounts Receivable Turnover

17) Receivables Turnover Ratio
Measures how quickly a company collects its accounts receivable

Receivables Turnover = Sales / Average Accounts Receivable

18) Days Payable Outstanding (DPO)
Measures the average number of days a company pays its suppliers

DPO = (Average Accounts Payable / COGS) x Number of Days

Or

DPO = Number of Days / Payables Turnover

19) Payables Turnover Ratio
Measure the rate at which a company pays off its suppliers

Payables Turnover = COGS / Average Accounts Payable

20) Fixed Assets Turnover Ratio
Measures how efficiently a company is using its fixed assets in generating revenue

Fixed Assets Turnover Ratio = Revenue / Average Fixed Assets

21) Working Capital Turnover Ratio
Measures pound for pound how much a company is turning its working capital investment into revenue

Working Capital Turnover Ratio = Revenue / Average Working Capital

22) Cash Conversion Cycle
An efficiency ratio which measures how effectively a company is managing its working capital

Cash Conversion Cycle = DSO + DIO – DPO

DSO: days sales outstanding = (Average Accounts Receivable × 365) / Credit Sales
DIO: days inventory outstanding = (Average Inventories × 365) / Cost of Goods Sold
DPO: days payables outstanding = (Average Accounts Payable × 365) / Cost of Goods Sold

VI. Shareholder Ratios

23) P/E Ratio
Measures whether the share price of a company is fairly valued, undervalued or overvalued

P/E Ratio = Current Share Price / Earnings Per Share

24) P/B Ratio
Measures the proportion of the current market price of a share of a company’s common stock to the book value per share of the company

P/B Ratio = Current Share Price / Book Value Per Share

25) Dividend Payout Ratio
The percentage of a company’s earnings distributed to investors as dividends

Dividend Payout Ratio = Dividends Per Share / Earnings Per Share = Dividends Paid / Net Income

26) Dividend Yield
Measures the dividend per share paid by a company as a percentage of its current share price

Dividend Yield = Dividends Per Share / Share price = Dividends Paid / Market Cap

27) Retention Ratio
Opposite of Dividend Payout Ratio. It’s the earnings retained and reinvested by the company

Retention Ratio = 1 – Payout Ratio = Retained Earnings / Total Earnings

VII. Return Ratios

28) ROA (Return on Assets)
Measures the efficiency of a company in using its assets to generate net income

ROA = Net Income / Average Total Assets

29) ROE
Measure of the profitability of stockholders’ investments

ROE = Net Income / Average Shareholders’ Equity

30) ROCE (Return on Capital Employed)
Measures the profitability of a company’s operating profit as a percentage of its capital employed. Capital employed is the sum of stockholders’ equity and long-term finance

ROCE = Net Income / Total Capital Employed

We have also seen analysts using EBIT to calculate ROCE:

ROCE = EBIT / Total Capital Employed

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