What are Financial Ratios?

Financial ratios are the indicators of the financial performance of companies. Different financial ratios indicate the company’s results, financial risks, and working efficiency, like the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratios, stability ratios, etc.

List of Top 28 Financial Ratios with Formulas & Types

Below are the types and list of financial ratios with formulas: –

  • Current RatioQuick RatioAbsolute Liquidity RatioCash RatioInventory Turnover RatioInventory Turnover RatioInventory Turnover Ratio measures how fast the company replaces a current batch of inventories and transforms them into sales. Higher ratio indicates that the company’s product is in high demand and sells quickly, resulting in lower inventory management costs and more earnings.read moreReceivables Turnover RatioCapital Turnover RatioAsset Turnover RatioNet Working Capital RatioCash Conversion CycleEarnings MarginReturn on InvestmentReturn on EquityEarnings Per ShareOperating LeverageFinancial leverageTotal LeverageDebt-Equity RatioInterest Coverage RatioDebt Service Coverage RatioFixed Asset RatioCurrent Asset to Fixed AssetProprietary RatioFixed Interest CoverFixed Dividend CoverCapacity RatioActivity RatioEfficiency Ratio

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Liquidity Ratio Analysis

The first type of financial ratio analysis is the liquidity ratio. It aims to determine a business’s ability to meet its financial obligations during the short term and maintain its short-term debt-paying ability. One can calculate the liquidity ratio in multiple ways. They are as follows: –

#1 – Current Ratio

The current ratioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it’ short-term loans within a year. Current ratio = current assets/current liabilities read more is a working capital ratio or banker’s ratio. The current ratio expresses the relationship between a current asset to current liabilities.

Formula = Current Assets / Current Liabilities

One can compare a company’s current ratio with the past current ratio; this will help to determine if the current ratio is high or low at this period in time.

The ratio of 1 is ideal; if current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more are twice a current liability. No issue will be in repaying liability. However, if the ratio is less than 2, repayment of liability will be difficult and affect the work.

#2 – Acid Test Ratio/ Quick Ratio

Generally, one can use the current ratio to evaluate an enterprise’s short-term solvencySolvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.read more or liquidity position. Still, it is often desirable to know a firm’s more immediate status or instant debt-paying ability than that indicated by the current ratio for this acid test financial ratio. That is because it relates the most liquid assetsLiquid AssetsLiquid Assets are the business assets that can be converted into cash within a short period, such as cash, marketable securities, and money market instruments. They are recorded on the asset side of the company’s balance sheet.read more to current liabilities.

Acid Test Formula = (Current Assets -Inventory)/(Current Liability)

One can write the quick ratio as: –

Quick Ratio Formula = Quick Assets / Current Liabilities

Or

Quick Ratio Formula = Quick Assets / Quick Liabilities

#3 – Absolute Liquidity Ratio

Absolute liquidity helps to calculate actual liquidity. And for that, inventory and receivables are excluded from current assets. In addition, some assets ban to understand better liquidity. Ideally, the ratio should be 1:2.

Absolute Liquidity = Cash + Marketable SecuritiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company’s balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more + Net Receivable and Debtors

#4 – Cash Ratio

The Cash ratio is useful Cash Ratio Is UsefulCash Ratio is calculated by dividing the total cash and the cash equivalents of the company by total current liabilities. It indicates how quickly a business can pay off its short term liabilities using the non-current assets.read more for a company undergoing financial trouble.

Cash Ratio Formula = Cash + Marketable Securities / Current Liability

If the ratio is high, then it reflects the underutilization of resources. If the ratio is low, it can lead to a problem in the repayment of bills.

Turnover Ratio Analysis

The second type of financial ratio analysis is the turnover ratio. The turnover ratio is also known as the activity ratio. This ratio indicates the efficiency with which an enterprise’s resources utilize. Again, the financial ratio can be calculated separately for each asset typeAsset TypeAssets are the resources owned by individuals, companies, or governments expected to generate future cash flows over a long period. There are broadly three types of asset distribution: 1. Based on convertibility (current and non-current assets), 2. Physical existence (tangible and intangible assets), 3. Usage (operating and non-operating assets)read more.

The following are financial ratios commonly calculated:-

#5 – Inventory Turnover Ratio

This financial ratio measures the relative inventory size and influences the cash available to pay liabilities.

Inventory Turnover Ratio Formula = Cost of Goods Sold / Average Inventory

#6 – Debtors or Receivable Turnover Ratio

The receivable turnover ratio shows how often the receivable turns into cash.

Receivable Turnover Ratio Formula = Net Credit Sales / Average Accounts Receivable

#7 – Capital Turnover Ratio

The capital turnoverCapital TurnoverCapital turnover determines the organization’s capital utilization efficiency and is calculated as a ratio of total annual turnover divided by the total amount of stockholder’s equity. The higher the ratio, the better the utilization of the capital employed.read more ratio measures the effectiveness with which a firm uses its financial resources.

Capital Turnover Ratio Formula = Net Sales (Cost of Goods Sold) / Capital Employed

#8 – Asset Turnover Ratio

This financial ratio reveals the number of times the net tangible assetsNet Tangible AssetsNet Tangible Assets is the value derived from the company’s total assets minus all intangible assets. Net Tangible Assets per share is calculated by dividing the net assets by the outstanding number of equity shares.read more turns over during a year. The higher the ratio better it is.

Asset Turnover Ratio Formula = Turnover / Net Tangible Assets

#9 – Net Working Capital Turnover Ratio

This financial ratio indicates whether or not working capital has been utilized effectively in sales. Net Working CapitalNet Working CapitalThe Net Working Capital (NWC) is the difference between the total current assets and total current liabilities. A positive net working capital indicates that a company has a large number of assets, while a negative one indicates that the company has a large number of liabilities.read more signifies the excess of current assets over current liabilities.

Net Working Capital Turnover Ratio Formula = Net Sales / Net Working Capital

#10 – Cash Conversion Cycle

The Cash Conversion CycleCash Conversion CycleThe Cash Conversion Cycle (CCC) is a ratio analysis measure to evaluate the number of days or time a company converts its inventory and other inputs into cash. It considers the days inventory outstanding, days sales outstanding and days payable outstanding for computation.read more is the total time taken by the firm to convert its cash outflows into cash inflows (returns).

Cash Conversion Cycle Formula = Receivable Days + Inventory Days – Payable Days

Operating Profitability Ratio Analysis

The third type of financial ratio analysis is the operating profitability ratio. The profitability ratio helps to measure a company’s profitability through this efficiency of business activity. The following are the important profitability ratiosImportant Profitability RatiosProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more:-

#11 – Earning Margin

It is the ratio of net income to turnover expressed in percentage. It refers to the final net profit used.

Earning Margin formula = Net Income / Turnover * 100

#12 – Return on Capital Employed or Return On the Investment

This financial ratio measures profitability concerning the total capital employed in a business enterprise.

Return on Investment formula = Profit Before Interest and Tax / Total Capital Employed

#13 – Return On Equity

Return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more derives by dividing net income by shareholder’s equity. It provides a return that management realizes from the shareholder’s equity.

Return on Equity Formula = Profit After Taxation – Preference Dividends / Ordinary Shareholder’s Fund * 100

#14 – Earnings Per Share

EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company’s performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more derives by dividing the company’s profit by the total number of shares outstanding. It means profit or net earnings.

Earnings Per Share Formula = Earnings After Taxation – Preference Dividends / Number of Ordinary Shares

Before investing, the investor uses all the above ratios to maximize profit and analyze risk. He can easily compare and predict a company’s future growth through ratios. It also simplifies the financial statementFinancial StatementFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.

Business Risk Ratios

The fourth type of financial ratio analysis is the business risk ratio. Here, we measure how sensitive the company’s earnings are concerning its fixed costs and the assumed debt on the balance sheet.

#15 – Operating Leverage

Operating leverageOperating LeverageOperating Leverage is an accounting metric that helps the analyst in analyzing how a company’s operations are related to the company’s revenues. The ratio gives details about how much of a revenue increase will the company have with a specific percentage of sales increase – which puts the predictability of sales into the forefront.read more is the percentage change in operating profit relative to sales. It measures how sensitive the operating income is to the change in revenues. The greater the use of fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more, the more significant the impact of a change in sales on a company’s operating income.

Operating Leverage Formula = % Change in EBIT / % Change in Sales

#16 – Financial Leverage

Financial leverage is the percentage change in net profit relative to operating profit, and it measures how sensitive the net income is to the change in operating income. Financial leverage primarily originates from the company’s financing decisions (debt usage).

Financial Leverage Formula = % Change in Net Income / % Change in EBIT

#17 – Total Leverage

Total leverage is the percentage change in net profit relative to its sales. The total leverage measures how sensitive the net income is to the change in sales.

Total Leverage Formula = % Change in Net Profit / % Change in Sales

Financial Risk Ratio Analysis

The fifth type of financial ratioType Of Financial RatioFinancial ratios are of five types which are liquidity ratios, leverage financial ratios, efficiency ratio, profitability ratios, and market value ratios. These ratios analyze the financial performance of a company for an accounting period.read more is the financial risk ratio. Here, we measure how leveraged the company is and placed concerning its debt repayment capacity.

#18 – Debt Equity Ratio

Debt Equity Formula = Long Term Debts / Shareholder’s Fund

It helps to measure the extent of equity to repay debt. One may use it for long-term calculations.

#19 – Interest Coverage Ratio Analysis

This financial ratio signifies the ability of the firm to pay interest on the assumed debt.

Interest Coverage Formula = EBITDA / Interest Expense

  • Higher interest coverage ratios imply the greater ability of the firm to pay off its interests.If interest coverage is less than 1, then EBITDA is insufficient to pay off interest, implying finding other ways to arrange funds.

#20 – Debt Service Coverage Ratio (DSCR)

The Debt Service Coverage RatioDebt Service Coverage RatioDebt service coverage (DSCR) is the ratio of net operating income to total debt service that determines whether a company’s net income is sufficient to cover its debt obligations. It is used to calculate the loanable amount to a corporation during commercial real estate lending.read more tells us whether the operating income is sufficient to pay off all obligations related to debt in a year.

Debt Service Coverage Formula = Operating Income / Debt Service

Operating IncomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.read more is nothing but EBIT

Debt Service is Principal Payments + Interest Payments + LeasePayments + Interest Payments + LeaseLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration.read more Payments

  • A DSCR of less than 1.0 implies that the operating cash flows are insufficient for debt servicing, indicating negative cash flows.

Stability Ratios

The sixth type of financial ratio analysis is the stability ratio. It is used with a long-term vision and to check the company’s stability in the long run. One can calculate this type of ratio analysis in multiple ways. They are as follows: –

#21 – Fixed Asset Ratio

This ratio one may use to know whether the company is having good fun or not to meet the long-term business requirement.

Fixed Asset Ratio Formula = Fixed Assets / Capital Employed

The ideal ratio is 0.67. If the ratio is less than 1, one can use it to purchase fixed assets.

#22 – Ratio to Current Assets to Fixed Assets

Ratio to Current Assets to Fixed Assets = Current Assets / Fixed Assets

IIf the ratio increases, profit increases and reflects the business expansion. If the ratio decreases, trading is loose.

#23 – Proprietary Ratio

The proprietary ratio is the ratio of shareholder fundsShareholder FundsShareholder Fund (SF) is the fund available to stakeholders after all liabilities have been met in the event of a company’s liquidation.read more to total tangible assets; it discusses a company’s financial strength. Ideally, the ratio should be 1:3.

Proprietary Ratio Formula = Shareholder Fund / Total Tangible Assets

Coverage Ratios

The seventh type of financial ratio analysis is the coverage ratioCoverage RatioThe coverage ratio indicates the company’s ability to meet all of its obligations, including debt, leasing payments, and dividends, over any specified period. A higher coverage ratio indicates that the business is a stronger position to repay its debt. Popular coverage ratios include debt, interest, asset, and cash coverage.read more. This ratio analysis Ratio AnalysisRatio analysis is the quantitative interpretation of the company’s financial performance. It provides valuable information about the organization’s profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.read more one may use to calculate dividends needed to pay to investors or interest to the lender. The higher the cover, the better it is. One may estimate it in the below ways: –

#24 – Fixed Interest Cover

It measures business profitability and its ability to repay the loan.

Fixed Interest Cover Formula = Net Profit Before Interest and Tax / Interest Charge

#25 – Fixed Dividend Cover

It helps to measure the dividends needed to pay the investor.

Fixed Dividend Cover Formula = Net Profit Before Interest and Tax / Dividend on Preference Share

Control Ratio Analysis

The eighth type of financial ratio analysis is the control ratio. It controls things by management. For example, this ratio analysis helps management check favorable or unfavorable performance.

#26 – Capacity Ratio

For this type of ratio analysis, one can use the formula below for the same.

Capacity Ratio Formula = Actual Hour Worked / Budgeted Hour * 100

#27 – Activity Ratio

For calculating a measure of activity below, one may use the formula:

Activity Ratio Formula = Standard Hours for Actual Production / Budgeted Standard Hour * 100

#28 – Efficiency Ratio

For calculating productivity, below is the formula:

Efficiency Ratio Formula = Standard Hours for Actual Production / Actual Hour Worked * 100

If it is 100% or more, it is considered favorable. But, if it is less than 100%, it is unfavorable.

Financial Ratios Video

This article is a guide to Financial Ratios. We list the top 28 financial ratios, the financial ratio formula, types, examples, and interpretations. You may learn more about ratio analysis from the following articles: –

  • Working Capital Turnover Ratio FormulaWorking Capital Turnover Ratio FormulaWorking Capital Turnover Ratio helps in determining that how efficiently the company is using its working capital (current assets – current liabilities) in the business and is calculated by diving the net sales of the company during the period with the average working capital during the same period.read moreCash Ratio FormulaCalculate Operating Expense RatioLimitations of Ratio AnalysisLimitations Of Ratio AnalysisThere are some limitations to ratio analysis, such as the fact that it only considers quantitative aspects and completely ignores qualitative aspects, that it does not consider the reasons for fluctuation of amounts, which could lead to inaccurate results, and that it only shows the comparison or trend.read more