Financial Ratios

Every company needs to measure its performance objectively. Please find a list below of some of the common financial ratios and metrics we use with our clients. We compare our clients’ numbers to their respective industry averages as well as overall business criteria.

 
LIQUIDITY RATIOS

WORKING CAPITAL

Total Current Assets - Total Current Liabilities

Explanation:  This metric is a measure of both a company’s efficiency and its short-term financial health. Positive working capital means that the company is able to pay off its short-term liabilities. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets.

 

CURRENT RATIO

Total Current Assets / Total Current Liabilities

Explanation:  Generally, this metric measures the overall liquidity position of a company. It is certainly not a perfect barometer, but it is a good one. Watch for big decreases in this number over time. Make sure the accounts listed in "current assets" are collectible.

 
 

QUICK RATIO

(Cash + Accounts Receivable) / Total Current Liabilities

Explanation:  This is another good indicator of liquidity, although by itself, it is not a perfect one. If there are receivable accounts included in the numerator, they should be collectible. Look at the length of time the company has to pay the amount listed in the denominator (current liabilities).

 

INVENTORY DAYS

(Inventory / COGS) * 365

Explanation:  This metric shows how much inventory (in days) is on hand. It indicates how quickly a company can respond to market and/or product changes. Not all companies have inventory for this metric.

 

ACCOUNTS RECEIVABLE DAYS

(Accounts Receivable / Sales) * 365

Explanation:  This metric shows how much inventory (in days) is on hand. It indicates how quickly a company can respond to market and/or product changes. Not all companies have inventory for this metric.

 

ACCOUNTS PAYABLE DAYS

(Accounts Payable / COGS) * 365

Explanation:  This ratio shows the average number of days that lapse between the purchase of material and labor, and payment for them. It is a rough measure of how timely a company is in meeting payment obligations.

 
 
PROFITS AND PROFIT MARGINS

GROSS PROFIT MARGIN

(Sales - COGS) / Sales

Explanation: The financialmetric used to assess a firm's financial health by revealing the proportion of money left over from revenues after accounting for the cost of goods sold. Gross profit margin serves as the source for paying additional expenses and future savings.

 

NET PROFIT MARGIN

Adjusted Net Profit before Taxes / Sales

Explanation:  This is an important metric. In fact, over time, it is one of the more important barometers that we look at. It measures how many cents of profit the company is generating for every dollar it sells. Track it carefully against industry competitors. This is a very important number in preparing forecasts.

 

ADVERTISING TO SALES

Advertising Expense / Sales

Explanation:  This metric shows advertising expense for the company as a percentage of sales.

 

RENT TO SALES

RentExpense / Sales

Explanation:  This metric shows rent expense for the company as a percentage of sales.

 

PAYROLL TO SALES

PayrollExpense / Sales

Explanation:  This metric shows payroll expense for the company as a percentage of sales.

 
 
BORROWING RATIOS
 

EBITDA

Revenue – Expenses (excluding interest, tax depreciation, and amortization)

Explanation: Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

 
 

INTEREST COVERAGE RATIO

EBITDA / Interest Expense

Explanation:  This ratio measures a company's ability to service debt payments from operating cash flow (EBITDA). An increasing ratio is a good indicator of improving credit quality.

 
 

DEBT-TO-EQUITY RATIO

Total Liabilities / Total Equity

Explanation:  This Balance Sheet leverage ratio indicates the composition of a company’s total capitalization -- the balance between money or assets owed versus the money or assets owned. Generally, creditors prefer a lower ratio to decrease financial risk while investors prefer a higher ratio to realize the return benefits of financial leverage.

 
 

DEBT LEVERAGE RATIO

Total Liabilities / EBITDA

Explanation:  This ratio measures a company's ability to repay debt obligations from annualized operating cash flow (EBITDA).

 
 
ASSETS RATIOS
 

RETURN ON EQUITY

Net Income / Total Equity

Explanation:  This measure shows how much profit is being returned on the shareholders' equity each year. It is a vital statistic from the perspective of equity holders in a company.

 
 

RETURN ON ASSETS

Net Income / Total Assets

Explanation:  This calculation measures the company's ability to use its assets to create profits. Basically, ROA indicates how many cents of profit each dollar of asset is producing per year. It is quite important since managers can only be evaluated by looking at how they use the assets available to them.

 
 

FIXED ASSET TURNOVER

Sales / Gross Fixed Assets

Explanation:  This asset management ratio shows the multiple of annualized sales that each dollar of gross fixed assets is producing. This indicator measures how well fixed assets are "throwing off" sales and is very important to businesses that require significant investments in such assets. Readers should not emphasize this metric when looking at companies that do not possess or require significant gross fixed assets.