Financial Analysis Ratios Glossary
The Financial Analysis Ratios Glossary contains all the ratios available for an analyst to analyze a company from different aspects.
Financial Analysis Ratios Glossary
Ratios are a crucial part of financial analysis. Specifically, ratios are used by analysts to analyze the financials of a company across time or of several companies at the same point in time since the ratios, by definition, are in relative terms.
This means that ratios are easily comparable representations of data, which provides benefits in making interpretations.
Ratios are mainly divided into liquidity, solvency, profitability, activity, and valuation ratios. Each type evaluates a company’s financial position or performance from a specific perspective.
It is worth noting that ratios should not be taken on their own to draw conclusions. It is important to make comparisons with the same company’s ratios in other years and with its peers and industry and to put the ratios in their appropriate context.
Thus, before relying on ratios to make assumptions about the company’s future financial performance or position, it is always important to scrutinize the ratios and think about how and why they may change in the future.
Liquidity Ratios
Liquidity ratios measure a company’s ability to meet its short-term obligations.
- Current Ratio: The current ratio measures how much current assets are available to cover each dollar of the current liabilities.
Current ratio = Current assets / Current liabilities
- Quick Ratio: The quick ratio, also known as the acid test ratio, measures how much of its most liquid current assets are available to cover each dollar of the current liabilities.
Quick ratio = (Cash + Short-term marketable securities + Receivables) / Current liabilities
- Cash Ratio: The cash ratio measures how much cash and cash equivalents are available to cover each dollar of the current liabilities.
Cash ratio = (Cash + Short-term marketable securities) / Current liabilities
- Defensive Interval Ratio (DIR): The defensive interval ratio measures how many days the company can operate, relying only on its most liquid assets, without needing to tap into other financial resources.
Defensive interval ratio (DIR) = (Cash + Short-term marketable securities + Receivables) / Daily cash expenditures
Solvency Ratios
Solvency ratios, also known as leverage ratios, measure the extent to which the company’s assets are financed by debt and the company’s ability to meet its debt obligations.
Financial Leverage Ratio
The financial leverage ratio, also known as the equity multiplier, measures how much total assets the company owns for each dollar of shareholders’ equity invested.
An equity multiplier of 2x means that a 1% increase in net profit margin or total asset turnover ratio will translate to a 2% increase in return on equity.
Financial leverage ratio = Average total assets / Average shareholders’ equity
Total Debt
Total debt is defined as the total of short-term and long-term interest-bearing liabilities. This definition excludes liabilities such as accounts payable, which do not accrue interest.
Total debt = The total of interest-bearing short-term and long-term debt, excluding liabilities such as accrued expenses and accounts payable
Debt-to-assets Ratio
The debt-to-assets ratio measures the percentage of total assets that are financed by debt.
Debt-to-assets ratio = Total debt / Total assets
Debt-to-equity Ratio
The debt-to-equity ratio measures how much total debt the company uses to finance its assets for each dollar of equity it uses.
Debt-to-equity ratio = Total debt / Total shareholders’ equity
Debt-to-capital Ratio
The debt-to-capital ratio measures the percentage of invested capital that is financed by debt.
Debt-to-capital ratio = Total debt / (Total debt + Total shareholders’ equity)
Interest Coverage Ratio
The interest coverage ratio, also known as the time's interest earned (TIE) ratio, measures how many times the company can pay its interest expense using its EBIT, which is the income available to do so.
Interpreted in another way, it measures how much earnings before interest and taxes are available to cover each dollar of the interest payments.
Interest coverage ratio = Earnings before interest and taxes / Interest payments
Interest Burden
The interest burden measures the percentage of earnings before interest and taxes left after paying interest.
Interest burden = Earnings before taxes / Earnings before interest and taxes
Fixed Charge Coverage Ratio
The fixed charge coverage ratio (FCCR) measures how many times the company can pay its fixed charges, defined as interest and lease payments, using its income available to do so.
Interpreted in another way, it measures how much earnings before interest, taxes, and lease payments are available to cover each dollar of the interest and lease payments.
Fixed charge coverage ratio = (Earnings before interest and taxes + Lease payments) / (Interest payments + Lease payments)
Profitability Ratios
Profitability ratios measure the company’s ability to convert its total revenue into profit and its ability to generate profit from its resources.
Gross Profit Margin
The gross profit margin measures how much gross profit each dollar of total revenue is converted to.
Gross profit margin = Gross profit / Total revenue
Operating Profit Margin
The operating profit margin measures how much operating profit each dollar of total revenue is converted to.
Operating profit margin = Operating profit / Total revenue
EBIT Margin
The EBIT margin measures how much EBIT each dollar of total revenue is converted to.
EBIT margin = Earnings before interest and taxes / Total revenue
Pretax Margin
The pretax margin measures how much pretax earnings, also known as taxable income, each dollar of total revenue is converted to.
Pretax margin = Earnings before tax but after interest / Total revenue
Tax Burden
The tax burden measures how much the percentage of earnings before taxes left after paying taxes.
Tax burden = Net income / Earnings before taxes
Net Profit Margin
The net profit margin measures how much net income, also known as bottom-line earnings, each dollar of total revenue is converted to.
Net profit margin = Net income / Total revenue
Operating Return on Assets
The operating return on assets measures how much operating income the company generates for each dollar it invests in total assets.
Operating return on assets = Operating income / Average total assets
Return on Assets (ROA)
The return on assets measures how much net income the company generates for each dollar it invests in total assets.
Return on assets (ROA) = Net income / Average total assets
Return on Equity (ROE)
The return on equity measures how much net income the company generates for each dollar of shareholders’ equity invested.
Return on equity (ROE) = Net income / Average shareholders’ equity
Return on Invested Capital (ROIC), Pre-tax
The pre-tax return on invested capital measures how much earnings before interest and taxes (EBIT) the company generates for each dollar of invested capital.
Return on invested capital (ROIC), pre-tax = Earnings before interest and taxes (EBIT) / (Average interest-bearing debt + Average shareholders’ equity)
Return on Invested Capital (ROIC)
The return on invested capital measures how much net operating profit after taxes (NOPAT) the company generates for each dollar of invested capital.
Return on invested capital (ROIC) = [Earnings before interest and taxes (EBIT) * (1 - Effective tax rate)] / (Average interest-bearing debt + Average shareholders’ equity)
Return on Common Equity (ROCE)
The return on common equity measures how much net income attributable to common shareholders the company generates for each dollar of common shareholders’ equity.
Return on common equity (ROCE) = (Net income - Preferred dividends) / Average common shareholders’ equity
Activity Ratios
Activity ratios, also known as asset utilization or efficiency ratios, measure the company’s efficiency in conducting its daily operations, such as collecting its receivables and generating revenue from its assets.
Receivables Turnover Ratio
The receivables turnover ratio measures how many times the company collects its receivables and converts them into cash.
Receivables turnover ratio = Total revenue / Average receivables
Inventory Turnover Ratio
The inventory turnover ratio measures how many times the company sells and replaces its inventory.
Inventory turnover ratio = Cost of goods sold (COGS) / Average inventory
Payables Turnover Ratio
The payables turnover ratio measures how many times the company pays its suppliers.
Payables turnover ratio = Purchases / Average trade payables
Days of Sales Outstanding (DSO)
Days of sales outstanding measure how many days the company takes on average to collect its receivables and convert them into cash.
Days of sales outstanding (DSO) = 365 / Receivables turnover = 365 * Average receivables / Total revenue
Days of Inventory on Hand (DOH)
Days of inventory on hand measure how many days the company takes on average to sell and replace its inventory.
Days of inventory on hand (DOH) = 365 / Inventory turnover = 365 * Average inventory / Cost of goods sold
Number of Days of Payables
The number of days of payables, also known as days of payables outstanding (DPO), measures how many days the company takes on average to pay its suppliers.
Number of days of payables = 365 / Payables turnover = 365 * Average trade payables / Purchases
Cash Conversion Cycle (CCC)
The cash conversion cycle, also known as the net operating cycle, measures how many days the company takes on average to convert the cash it invests in inventory back into cash by selling its products and collecting the proceeds from customers.
Cash conversion cycle (CCC) = DOH + DSO - Number of days of payables
Working Capital Turnover Ratio
The working capital turnover ratio measures how much total revenue the company generates for each dollar invested in working capital.
Working capital turnover ratio = Total revenue / Average working capital
Fixed Assets Turnover (FATO) Ratio
The fixed assets turnover ratio measures much total revenue the company generates for each dollar it invests in net fixed assets.
Fixed assets turnover (FATO) ratio = Total revenue / Average net fixed assets
Total Assets Turnover (TATO) Ratio
The total assets turnover ratio measures how much total revenue the company generates for each dollar it invests in total assets.
Total assets turnover (TATO) ratio = Total revenue / Average total assets
Valuation Ratios
Valuation ratios measure the amount of a resource or flow, such as earnings, associated with the ownership of a specific claim, such as common stock.
Dividend Payout Ratio
The dividend payout ratio measures the percentage of net income attributable to common shares that the company pays as dividends to its common shareholders.
Dividend payout ratio = Common share dividends / Net income attributable to common shares
Retention Rate
The retention rate measures the percentage of net income attributable to common shares that the company retains for its future financing needs.
Retention rate = (Net income attributable to common shares - Common share dividends) / Net income attributable to common shares = 1 - Dividend payout ratio
Sustainable Growth Rate
The sustainable growth rate, also known as the organic growth rate, measures the rate with which the company can grow by only retaining a portion of its net income and investing it in its return on equity.
Sustainable growth rate = Retention rate * Return on equity
Basic Earnings Per Share (EPS)
Basic earnings per share measure how much net income attributable to common shares the company generates for each share of its common stock.
Basic earnings per share (EPS) = (Net income - Preferred dividends) / Weighted average number of ordinary shares outstanding
Diluted Earnings Per Share (EPS)
Diluted earnings per share measures how much net income attributable to common shares the company generates for each share of its common stock after accounting for the dilution effect of securities that require the issuance of new shares, such as options.
Diluted earnings per share (EPS) = (Net income - Preferred dividends) / (Weighted average number of ordinary shares outstanding + Number of common shares that would have been issued at conversion)
Book Value Per Share (BVPS)
Book value per share measures how much of the company’s common stockholders’ equity, also known as the book value of the firm, is attributable to each common share outstanding.
Book value per share (BVPS) = Common stockholders’ equity / Total number of common shares outstanding
Free Cash Flow to Equity (FCFE)
Free cash flow to equity, also known as levered free cash flow, measures how much cash the company generates for its equity investors after accounting for the cash outflows required to support operations and maintain capital assets.
Free cash flow to equity also accounts for the cash outflows to repay debt and the inflows from borrowing activities. Thus, it is not comparable across companies with different capital structures.
Free cash flow to equity (FCFE) = Cash flow from operating activities (CFO) - Investment in fixed capital + Net borrowing
Free Cash Flow to the Firm (FCFF)
Free cash flow to the firm, also known as unlevered free cash flow or free cash flow from operations (FCFO), measures how much cash the company generates for all its investors after accounting for the cash outflows required to support operations and maintain capital assets.
Note that the addition of net interest expense is only required if interest expense was deducted in the calculation of the cash flow from operating activities, which is not something all companies elect to do.
Free cash flow to the firm (FCFF) = Cash flow from operating activities (CFO) + [Interest expense * (1 - Tax rate)] - Investment in fixed capital
Bottom Line
In closing, we would like to remind you that this list is not intended to be an exhaustive list of financial ratios. However, the ratios we discussed above are only the most general and commonly used ones.
Note that the importance of each ratio depends on the company’s industry and unique circumstances. Moreover, specific ratios and metrics are used to evaluate the performance of companies according to their industries and unique characteristics.
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