Ratio Analysis Equations

current ratio

current assets / current liabilities

ability to meet short-term obligations/ pay off current liabilities with liquid assets

• higher = can meet obligations

• lower = cannot meet obligations

quick ratio

(current assets - inventory) / current liabilities

measures short-term liquidity of a firm after removing the effects of the least liquid asset (inventory)

• > 1: can cover liabilities w/o inventory

• ~ 1: just enough to meet obligations

• < 1: cannot cover liabilities

“A company has X% of its current liabilities covered by current assets”

cash ratio

cash / current liabilities

ability to pay off current liabilities w/ cash

• > 1: cash can cover liabilities

• ~ 1: just enough to meet obligations

• < 1: cannot cover liabilities

“A company has X% of its short-term obligations covered by cash and equivalents”

working capital 

current assets - current liabilities

measures how much short-term assets are available to pay off obligations

• positive: good liquidity

• negative: more liability

“A company has $X available to fund daily operations after paying short-term debts”

net working capital to total assets

(current assets - current liabilities) / total assets

how much of total assets is financed by working capital

• positive: current assets exceed current liabilities

• ~ 0: just enough current assets to cover short-term debts

• negative: current liabilities exceed current assets

“X% of firm’s total assets are financed by net working capital”

inventory turnover

COGS / avg inventory

how many times inventory is sold and replaced over a specific period

• high: inventory sells quickly; efficient management

• low: inventory sells slowly; possible overstocking

“A company sold and replaced its inventory X times during the year”

days sales in inventory

365 / inventory turnover

average number of days a company takes to sell its entire inventory during a period

• low: inventory sells quickly

• high: inventory sells slowly

“A company takes about X days on average to sell its inventory”

receivable turnover 

credit sales/ accounts receivable

how many times a company collects A/R during given period

• high: efficient credit collection

• low: possible collection issues

“A company collects its average receivables about X times per year”

days sales in receivables

365 / receivable turnover

average number of days it takes to convert A/R into cash

• low: efficient collection

• high: weak credit control

“A company takes about X days on average to collect cash from customers”

average payment period

accounts payable / (COGS/ 365)

measures average days company takes to pay its suppliers and manages its accounts payable

• high: takes long to pay back; conserves cash but harms supplier relationships

• low: pays suppliers quickly; good for relationships but strains cash flow

“A company takes about X days on average to pay its suppliers)

net working capital turnover

sales / net working capital

how efficiently a company uses net working capital to generate sales

• high: efficient

• low: inefficient operations

“A company generates $X in sales for every $1 of working capital”

fixed asset turnover

sales / net fixed assets

how efficiently a company uses fixed assets (property, plant, equipment)

• high: efficient

• low: inefficient

“A company generates $X for every $1 invested in fixed assets”

total asset turnover

sales / total assets

how efficiently a company uses all assets

• high: efficient

• low: inefficient

“A company generates $X in sales for every $1 invested in total assets”

total debt ratio

total debt / total assets

measures proportion of assets financed through debt rather than owner’s equity

• 0 - 0.5: lower leverage/ risk

• 0.5-0.7: moderate leverage/ risk

• > 0.7: high leverage/ risk

“X% of a company’s assets are financed with debt”

debt-equity ratio

total debt / total equity

measure proportion of company’s financing that comes from debt compared to equity

• > 1: higher risk

• ~ 1: balanced

• < 1: low debt

“A company finances $X of debt for every $1 of equity”

equity multiplier

total assets / total equity

1 / debt ratio

1 + debt-equity ratio

how much of assets are financed by shareholders’ equity vs by debt

• ~ 1: mostly equity; low leverage

• > 1: some debt: higher leverage

• much > 1: high financial leverage

“A company has $X of assets for every $1 of equity”

long term debt ratio

long term debt / (long term debt + total equity)

measures percentage of total firm capitalization funded by long term debt

• low (<0.3): more equity; low risk 

• moderate (0.3-0.6): balanced

• high(>0.6): reliance debt; high risk

“X% of the company’s assets are financed by long-term debt:

time interest earned ratio

EBIT / interest

how easily a company can pay interest with operating income (EBIT)

• < 1: cannot cover interest

• > 4 : strong ability to cover

“A company earns X times its interest obligations”

fixed charge coverage

earnings before fixed charges / before tax fixed charges

how earnings before fixed payments and taxes cover fixed financial obligations

• < 1: insufficient

• > 2: strong ability to cover

“A company earns X times its total fixed charges”

cash coverage ratio

(EBIT + depreciation) / interest

how cash-based earnings can cover interest expense

• < 1: insufficient

• > 2: strong ability to cover

“A company generates X times its interest in cash earnings”’

operating profit margin

EBIT / net sales

percentage of revenue that remains after covering operating expenses but before interest and taxes

• high: strong profitability

• low: weak efficiency

“A company retains $X per dollar of revenue as operating profit”

profit margin (return on sales)

net income / net sales

percentage of revenue that remains after all expenses including interest and taxes

• high: strong profitability

• low: weak profitability

“X% of sales converts to net profit after all costs, interest, and taxes”

return on assets

net income / total assets

how a company uses total assets to generate net profit

• high: efficient asset utilization

• low: inefficient use of assets

“A company generates $X in net profit for every $1 spent on assets”

return on equity

net income / total equity

profitability of a company relative to shareholders’ equity

• high: efficient use of shareholders’ investments

• low: inefficient use of shareholders’ investments

“A company earns X% on the equity invested by shareholders”

DuPont Formula

ROE = Profit Margin x Asset Turnover x Equity Multiplier

how a company generates returns for shareholders; assessing profitability, asset management, and financial leverage

“Shareholders earn $X per $1 of equity”

price-earnings ratio

price per share / earnings per share

how much investors are willing to pay for each dollar of a company’s earnings

• high: investors expect growth

• low: undervalued or low growth

“Investors pay X times the company’s earnings for each share”

PEG ratio

price earnings ratio / earnings growth rate (%)

stock valuation relative to growth

• < 1: undervalued relative to growth

• ~ 1: fairly valued relative to growth

• > 1: overvalued relative to growth

price-sales ratio

price per share / earnings per share

stock valuation based on sales

• high: growth expectation

• moderate: fair valuation

• low: potential undervaluation 

“Investors are willing to pay X times the annual sales to own the company”

market to book ratio

market value per share / book value per share

compares market to book value, assessing whether its over or undervalued relative to accounting value

• > 1: stock above book; expect growth

• < 1: stock below book; maybe undervaluation

“Investors value the company at X times its net book value”

Tobin’s Q ratio

market value of assets / replacement cost of assets

assessing if market value of firm covers cost of replacing assets

• >1: market value higher; should invest in new assets

• <1: replacement cost higher; overcapitalized or undervalue

enterprise value - EBITDA ratio

enterprise value / EBITDA

enterprise value = MV of equity + debt + PS - cash

EBITDA = earnings before interest, taxes, depreciation and amortization

total valuation relative to operating cash earnings

• high: expect growth; overvalued

• low: operationally weak; undervalued

“Investors would pay X times EBITDA for the entire company”