Using Ratio Analysis to Evaluate Financial Performance

What is liquidity?

the ability of a company to meet its short-term obligations

What is solvency?

A company’s capacity to meet long-term debt obligations

What is profitability?

how efficiently a company generates profits relative to its revenues, assets, or equity

What is efficiency?

how well a company uses its assets and manages its operations

What is market valuation?

metrics that show the company’s value in the eyes of investors

What are the key liquidity ratios to know?

Current ratio and quick ratio

What is the meaning of the current ratio?

it measures a company’s ability to pay off its short-term liabilities with short-term assets

What is the formula for current ratio?

= current assets / current liabilities

What is the meaning of the quick ratio?

it excludes inventory from current assets, offering a stricter measure of liquidity

What is the formula for quick ratio?

= current assets - inventory / current liabilities

What is the ideal range for current and quick ratio?

> 1 indicates good short-term financial health

What are the solvency ratios?

debt to equity and interest coverage ratio

What is the meaning of debt to equity ratio?

shows the proportion of debt versus equity financing

What is the formula of debt to equity?

total liabilities/shareholders’ equity

What is the ideal range for debt to equity?

it indicates lower values are preferred but vary by industry

what is the meaning of the interest coverage ratio?

it indicates how easily a company can pay interest expenses

What is the formula of the interest coverage ratio?

= EBIT / Interest expense

what are the profitability ratios?

gross profit margin, net profit margin, return on assets, and return on equity

what is the meaning of gross profit margin?

it reflects the proportion of revenue left after deducting cost of goods sold

What is the formula for Gross profit margin?

= gross profit / revenue x 100

What is the meaning of net profit margin?

it shows how much profit a company earns per dollar of revenue

What is the formula for net profit margin

= net income/revenue * 100

What is the meaning of Return on assets?

it measures how efficiently a company uses its assets to generate profit

What is the formula for return on assets

= net income / total assets * 100

What is the meaning of return on equity?

it indicates how effectively a company uses equity to generate profit

What is the formula for ROE?

= Net income / shareholders’ equity * 100

What are the efficiency ratios ?

asset turnover ratio, inventory turnover ratio, and accounts receivable turnover ratio

what is the meaning of the asset turnover ratio

it reflects how efficiently a company uses its assets to generate revenue

what is the formula for the asset turnover ratio?

= revenue / total assets

What is the meaning of the inventory turnover ratio

it measures how often inventory is sod and replaced over a period

What is the formula for the inventory turnover ratio?

= cost of goods sold / average inventory

What is the meaning of the accounts receivable turnover ratio

it shows how efficiently a company collects payments from customers

What is the formula for accounts receivable turnover ratio?

= net credit sales / average accounts receivable

What are the key market valuation ratios?

Price to Earnings, earnings per share, and dividend yield

What is the meaning of the price to earnings ratio?

it reflects investor expectations for earnings growth

what is the formula for the P/E Ratio?

market price per share / earnings per share (EPS)

What is the meaning of earnings per share (EPS)

It indicates the profitability available to each outstanding share

what is the formula for earnings per share

= net income - preferred dividends / average outstanding shares

What is the meaning of the dividend yield?

it shows the return on investment from dividends

What is the formula for the dividend yield?

= annual dividends per share / market price per share * 100