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Common Financial and Accounting Ratios & Formulas

Accounting ratios are among the most popular and widely used tools of financial analysis because if properly analyzed, they help us identify areas that require further analysis on financial statements of corporations. A ratio can help us uncover conditions and trends that are difficult to find by inspecting individual components making up the ratio. For instance, knowing how much cash a company has in the bank might be a little useful, but working out a ratio to determine how much cash a company has, versus how much short term debt it has coming up is a lot more useful. Accounting ratios help us do just that. In fact, accountants admit that interpreting financial data is the most challenging aspect of ratio analysis. First of all, what is a ratio?

A ratio is a mathematical relation between two quantities expressed as a percentage, a rate or proportion. For example a ratio can derive the answer \$900 or can be expressed a 100% or 9:1 or just “9” In this tutorial, we will go over 4 major categories of accounting ratios that are known as the 4 building blocks of financial statement analysis. They are i) liquidity & efficiency ratios ii) solvency ratios iii) profitability ratios and iv)market value ratios.

i) Short Term Solvency or Liquidity Ratios Current ratio = Current assets / Current liabilities Quick ratio = (Current assets – inventory) / Current liabilities Cash ratio = Cash / current liabilities Net Working Capital = Net working capital / total assets Internal measure = Current assets / average daily operating costs

ii) Long Term Solvency or Financial Leverage Ratios Total debt ratio = (Total assets – total equity) / Total assets Debt to Equity ratio = Total debt / total equity Equity Multiplier = Total assets / total equity Long term debt ratio = Long term debt / (Long term debt + total equity) Times interest earned = Earnings before Interest & Taxes / Interest Cash coverage ratio = (Earnings before Interest & Taxes + Depreciation) / Interest

iii) Asset use or turnover ratios Inventory turnover = Cost of goods sold / Inventory Days’ sales in Inventory = 365 days / Inventory turnover Receivables turnover = Sales / Accounts receivable Days’ sales in receivables = 365 days / Receivables turnover Net Working Capital (NWC) turnover = Sales / Net Working Capital Fixed asset turnover = Sales / net fixed assets Total asset turnover = Sales / total assets

iv) Profitability Ratios Profit margin = Net income / Sales Return on Assets (ROA) = Net income / total assets Return on Equity (ROE) = Net income / Total equity ROE = (Net Income / Sales) x (Sales / Assets) x (Assets / Equity)

v) Market Value Ratios Price to Earnings ratio = Price per share / Earnings per share Market-to-book ratio = Market value per share / book value per share