Financial Ratios
Evaluate any business using financial ratios
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Financial ratios are used to perform analysis on numbers found in company financial statements to assess the leverage, liquidity, valuation, growth, and profitability of a business.
What are financial ratios?
Financial ratios are simple formulas or fractions that you can use to compare two different items from a company’s financial statements.
The reason we do this is because these ratios can give you a lot more insight into how the company is performing than by looking at those financial statement line items separately.
Let’s say you are a brand new company and were looking at the balance sheet of your company. You have current assets of $1,000 split between cash ($500) and inventory that you intend to sell ($500).
This is a startup, so you’re doing the work yourself, but you needed materials to actually build the product you’re selling. You went to a supplier and got the materials needed and, for that, you paid $2,000 on net 30 terms.
That $2,000 is your current liabilities that you need to pay within 30 days and if you just looked at current assets and liabilities as lines on your balance sheet, it doesn’t tell you much.
But if we use the “quick ratio“, which is a measure of the liquidity of your company, we can see a problem:
Quick\: Ratio = \dfrac{Quick\: Assets}{Current\: Liabilities} = \dfrac{500}{2000} = 0.25You only have $500 in cash. This is only enough to cover 25% of your liabilities. What if you don’t sell your inventory in the next 30 days? Your business will struggle to repay the supplier and you’ll be in real trouble.
By using financial ratios, you can compare a lot of different business metrics to more deeply understand just what is going on with the company.
There are generally five types of financial ratio: (1) profitability, (2) liquidity, (3) management efficiency, (4) leverage, and (5) valuation & growth.
List of financial ratios
We’ve covered a lot of financial ratios on Study Finance (too many to list all on one page).
Below are the latest we’ve written in each category of ratio and, if you want more, you can click the links above to explore the ratio types and all of the examples we have.
Each ratio article will provide a detailed overview of the ratio, what it’s used for, and why.
They also explain the formula behind the ratio and provide examples and analysis to help you understand them.
Profitability ratios
- Return on Research Capital (RORC)Return on research capital (RORC) is a metric that describes the revenue generated by a company as a result of capital spent on research and development.
- Cash Turnover Ratio (CTR)The cash turnover ratio (CTR) a profitability and efficiency ratio that measures how many times a company uses its cash to generate revenues.
- Cash Earnings Per Share (Cash EPS)Cash earnings per share (Cash EPS) is a profitability ratio that compares a company’s cash flow against their volume of shares outstanding.
- Cash Return On Assets RatioThe cash return on assets (cash ROA) ratio is a measure of the operational cash flow against the total assets owned by a business.
- Return On Revenue (ROR)The return on revenue (ROR) ratio is a measure of company profitability based on its revenue.
Liquidity ratios
- Net DebtNet debt is a liquidity metric that measures a company’s ability to settle all of its debts should they need to be paid immediately.
- Inventory to Working Capital RatioInventory to working capital is a liquidity ratio that measures the amount of working capital that is tied up in inventory.
- Cash to Working Capital RatioThe cash to working capital ratio measures what percentage of the company’s working capital is made up of cash and cash equivalents such as marketable securities.
- Cash to Current Assets RatioCash to current assets is a liquidity ratio that measures how much of the current assets in a company are made up of cash and cash equivalents.
- Cash Flow Adequacy RatioThe cash flow adequacy ratio is used to determine if the cash flow generated by a company is sufficient to pay for its ongoing expenses—for example, reductions in long-term debt, acquisition of fixed assets or paying dividends to shareholders.
Efficiency ratios
- Sales to Operating Income RatioSales to operating income is an efficiency ratio that is used by companies to see how a company’s net sales compares to its operating income.
- Repairs and Maintenance Expense to Fixed Assets RatioThe repairs and maintenance expenses to fixed assets ratio is a measurement that evaluates and compares the total amount spent for repairs and maintenance against the total value of the assets being repaired and maintained.
- Investment Turnover RatioThe investment turnover ratio is a financial tool used to determine how efficiently a company is generating revenues using their debts and equity.
- Sales to Fixed Assets RatioThe sales to fixed assets ratio, also known as the fixed asset turnover ratio, measures the efficiency of a business in using fixed assets to generate revenue.
- Inventory to Sales RatioInventory to sales is an efficiency ratio that is used to determine the rate at which the company is liquidating its inventory.
Leverage ratios
- Interest Expense to Debt RatioThe interest expense to debt ratio (IE/D) determines the rate of interest paid by a business on its total debt.
- Financial Leverage IndexThe financial leverage index is a solvency ratio that measures the proportion of a company’s debt compared to its equity that is used to make money and produce income.
- Net Debt to EBITDA RatioThe net debt to EBITDA ratio is a leverage metric that measures the amount of net income that is available to pay down debt before covering interest, taxes, depreciation, and amortization expenses.
- Debt to EBITDA RatioThe debt to EBITDA ratio is a leverage metric that measures the amount of income that is available to pay down debt before covering interest, taxes, depreciation, and amortization expenses.
- Fixed Assets to Net Worth RatioFixed assets to net worth, also known as the non-current assets to net worth ratio, is a financial ratio used to measure the solvency of a company.
Valuation ratios
- Price Earnings to Growth and Dividend Yield (PEGY)Price earning to growth and dividend yield (PEGY) is a metric used in stock analysis that measures a stock’s potential for future earnings growth and dividend payments.
- Cash Reinvestment RatioThe cash reinvestment ratio, also known as the cash flow reinvestment ratio, is a valuation ratio used to measure the percentage of annual cash flow that the company invests back into the business as a new investment.
- Free Cash Flow to Sales RatioFree cash flow-to-sales is a performance ratio that looks into a company’s operating cash flows after subtracting all sales-relative capital expenditures.
- PEG RatioThe PEG ratio (price-earnings to growth) is a valuation metric that describes the relationship between the price of a stock, the earnings generated per share and the growth rate.
- Correlation CoefficientThe correlation coefficient, also called the Pearson correlation, is a metric that reflects the relationship between two numbers.
Coverage ratios
- Cash Flow to Debt RatioThe cash flow to debt ratio is a coverage ratio that reflects the relationship between a company’s operational cash flow and its total debt.
- Fixed Charge Coverage RatioThe fixed-charge coverage ratio reflects a company’s capacity to pay for its fixed expenses, like debt, interest and lease.
- Debt to Income Ratio (DTI)Debt to income (DTI) is a ratio measuring an individual’s ability to pay their debts.
- Debt to Capital RatioThe debt to capital ratio is a ratio that indicates how leveraged a company is by dividing its interest-bearing debt with its total capital.
- Preferred Dividend Coverage RatioThe preferred dividend coverage ratio shows a company’s capacity to pay preferred shareholders their dividends, which are predetermined and fixed.