Financial Ratios

PROFITABILITY RATIOS

1. Profit Margin

A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every rupee of sales a company actually keeps in earnings.

Profit Margin = (Profit After Tax / Sales) *100

Profit margin is very useful when comparing companies in similar industries.

2.  Asset Turnover

 The amount of sales generated for every rupee’s worth of assets. It is calculated by dividing sales in rupees by assets in rupees.

Asset Turnover= Sales / Average total assets

Where, “Sales” is the value of “Net Sales” or “Sales” from the company’s income statement, and “Average Total Assets” is the value of “Total assets” from the company’s balance sheet in the beginning and the end of the fiscal period divided by 2.

3. Return on Assets

An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s annual earnings by its total assets, ROA is displayed as a percentage.

Return on Assets = (Profit After Tax / Total Assets) * 100

ROA tells us what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry.

4. Return on Equity

A measure of a corporation’s profitability that reveals how much profit a company generates with the money shareholders have invested.

Return on Equity = ( Profit After Tax / Capital Employed) * 100

It is used as a general indication of the company’s efficiency; in other words, how much profit it is able to generate given the resources provided by its stockholders. Investors usually look for companies with returns on equity that are high and growing.

5.Earnings per Share

 The portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability.

Earnings Per Share = ( Profit After Tax / Weighted Average number of Shares)

‘Earnings per share’ is generally considered to be the single most important variable in determining a share’s price. It is also a major component of the price-to-earnings valuation ratio.

TURNOVER RATIOS

1. Inventory Turnover Ratio

The inventory turnover ratio measures the number of times a company sells its inventory during the year.

Inventory Turnover ratio = cost of goods sold / average inventory
where, average inventory = (beginning inventory + ending inventory)/2

A high inventory turnover ratio indicates that the product is selling well. It should be done by inventory categories or by individual product.

2. Debtors’ turnover ratio

Debtors’ turnover ratio indicates the relation between net credit sales and average accounts receivables of the year. This ratio is also known as Debtors’ Velocity.

Debtor turnover ratio = Net Credit Sales / Average Accounts Receivables
where, average accounts receivables = (opening debtors + closing debtors)/2
               credit sales = total sales – cash sales

The Debtor Turnover Ratio is a ‘performance ratio’, which means that it indicates the efficiency of a business. Efficiency and performance are linked, as efficient businesses are usually more profitable.

 

3. Creditors/Payables Turnover Ratio

 
It compares creditors with the total credit purchases. It signifies the credit period enjoyed by the firm in paying creditors. Accounts payable include both sundry creditors and bills payable. Creditors’ turnover ratio can be calculated in two forms, creditors’ turnover ratio and average payment period.

Creditors Turnover Ratio = credit purchase / average trade creditors

Average payment period ratio gives the average credit period enjoyed from the creditors.
average payment period = trade creditors / average daily credit purchase

 

4. Fixed assets turnover ratio

 
Fixed asset turnover is the ratio of sales (on the Profit and loss account) to the value of fixed assets (on the balance sheet). It indicates how well the business is using its fixed assets to generate sales.

fixed asset turnover = Sales / Average net fixed assets

Generally speaking, the higher the ratio, the better, because a high ratio indicates the business has less money tied up in fixed assets for each dollar of sales revenue.
The higher the Fixed Asset Turnover ratio, the more effective the company’s investments in Net Property, Plant, and Equipment have become.

SOLVENCY RATIOS

1. Debt to equity ratio

Debt to equity ratio is the measure of a company’s financial leverage calculated by dividing its total liabilities by stockholders’ equity. It indicates what proportion of equity and debt the company is using to finance its assets.

Debt Equity Ratio = Long term debt / (equity shareholder’s fund + Preferential capital)

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.
2. Interest Coverage Ratio

Interest coverage ratio (or Time interest earned ration) measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs.

Interest Coverage Ratio = EBIT / Interest

Failure to meet this obligation can bring legal action by firm creditors, possibly resulting in bankruptcy. Note that earnings before interest and taxes, rather than net income, are used in numerator. Because the interest is paid with pre-tax Rupees, the firm’s ability to pay current interest is not affected by taxes.

CURRENT RATIOS

1. Current Ratio

Current ratio measures the ability of an entity to pay its near-term obligations.

Current Ratio = (current assets, loans and advances + short term investments) / (current liabilities and provisions + short term debt)

“Current” usually is defined as within one accounting period. Current ratio provides the best single indicator of the extent to which the claims of short term creditors are covered by the assets that are expected t o be converted to cash fairly quickly, it is most commonly used measure of short-term solvency.

2. Quick Ratio

Quick Ratio = [(current assets, loans and advances + short term investments) – (Inventory + prepaid expenses)] / [(current liabilities and provisions + short term debt) – Provisions]

Quick ratio (or acid test ratio) provides a stricter definition of the company’s ability to make payments on current obligations. Ideally, this ratio should be 1:1. If it is higher, the company may keep too much cash on hand or have a poor collection program for accounts receivable. If it is lower, it may indicate that the company relies too heavily on inventory to meet its obligations.
CAPITAL MARKET RATIOS

1. Price-earnings ratio

A valuation ratio of a company’s current share price compared to its per-share earnings.

Price-earning ratio = Market Value of Share / Earning Per share(EPS)

2. Dividend Yield Ratio

The dividend yield ratio allows investors to compare the latest dividend they received with the current market value of the share as an indicator of the return they are earning on their shares. Note, though, that the current market share price may bear little resemblance to the price that an investor paid for their shares. Take a look at the history of a business’s share price over the last year or two and you will see that today’s share price might be a lot higher or a lot lower than it was a year ago, two years ago and so on.

Dividend Yield = (Latest Annual Dividends / Current market share price)

~ by rishabhjain1601 on June 29, 2009.