# Ratio Analysis

A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from an enterprise’s financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm’s creditors. Security analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.

Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percent value, such as 10%. Some ratios are usually quoted as percentages, especially ratios that are usually or always less than 1, such as earnings yield, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples. Given any ratio, one can take its reciprocal; if the ratio was above 1, the reciprocal will be below 1, and conversely. The reciprocal expresses the same information, but may be more understandable: for instance, the earnings yield can be compared with bond yields, while the P/E ratio cannot be: for example, a P/E ratio of 20 corresponds to an earnings yield of 5%.

Liquidity Analysis Ratios

Current Ratio

Current Assets

Current Ratio =              ————————

Current Liabilities

Quick Ratio

Quick Assets

Quick Ratio =                  ———————-

Current Liabilities

Quick Assets = Current Assets – Inventories

Net Working Capital Ratio

Net Working Capital

Net Working Capital Ratio =       ————————–

Total Assets

Net Working Capital = Current Assets – Current Liabilities

Profitability Analysis Ratios

Return on Assets (ROA)

Net Income

Return on Assets (ROA) =            ———————————-

Average Total Assets

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Return on Equity (ROE)

Net Income

Return on Equity (ROE) =             ——————————————–

Average Stockholders’ Equity

Average Stockholders’ Equity = (Beginning Stockholders’ Equity + Ending Stockholders’ Equity) / 2

Return on Common Equity (ROCE)

Net Income

Return on Common Equity =      ——————————————–

Average Common Stockholders’ Equity

Average Common Stockholders’ Equity = (Beginning Common Stockholders’ Equity + Ending Common Stockholders’ Equity) / 2

Profit Margin

Net Income

Profit Margin =              —————–

Sales

Earnings Per Share (EPS)

Net Income

Earnings per Share =                     ———————————————

Number of Common Shares Outstanding

Activity Analysis Ratios

Assets Turnover Ratio

Sales

Assets Turnover Ratio =               —————————-

Average Total Assets

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Accounts Receivable Turnover Ratio

Sales

Accounts Receivable Turnover Ratio =     ———————————–

Average Accounts Receivable

Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2

Inventory Turnover Ratio

Cost of Goods Sold

Inventory Turnover Ratio =         —————————

Average Inventories

Average Inventories = (Beginning Inventories + Ending Inventories) / 2

Capital Structure Analysis Ratios

Debt to Equity Ratio

Total Liabilities

Debt to Equity Ratio =                  ———————————-

Total Stockholders’ Equity

Interest Coverage Ratio

Income before Interest and Income Tax Expenses

Interest Coverage Ratio =            ——————————————————-

Interest Expense

Income before Interest and Income Tax Expenses = Income before Income Taxes + Interest Expense

Capital Market Analysis Ratios

Price Earnings (PE) Ratio

Market Price of Common Stock per Share

Price Earnings Ratio =                   ——————————————————

Earnings per Share

Market to Book Ratio

Market Price of Common Stock per Share

Market to Book Ratio =                ——————————————————-

Book Value of Equity per Common Share

Book Value of Equity per Common Share = Book Value of Equity for Common Stock / Number of Common Shares

Dividend Yield

Annual Dividends per Common Share

Dividend Yield =             ————————————————

Market Price of Common Stock per Share

Book Value of Equity per Common Share = Book Value of Equity for Common Stock / Number of Common Shares.

Dividend Payout Ratio

Cash Dividends

Dividend Payout Ratio =              ——————–

Net Income

ROA = Profit Margin X Assets Turnover Ratio

Profit Margin = Net Income / Sales Assets Turnover Ratio = Sales / Averages Total Assets