Financial Ratios Quick Reference

Liquidity Ratios

• Purpose: measure ability to pay short-term obligations within one year.
• Current ratio: $\frac{Current\ Assets}{Current\ Liabilities}$
• Quick ratio: $\frac{Current\ Assets - Inventories}{Current\ Liabilities}$
• Thresholds: aim for current ratio > 1; quick ratio around 1.5 is favorable for lenders.

Asset Management Ratios ( Efficiency )

• Inventory turnover: $\frac{Sales}{Inventory}$
  • Indicates how many times inventory is sold and replaced; higher is generally better if supported by sales.
• Days Sales Outstanding (DSO): $\text{DSO} = \frac{Accounts\ Receivable}{\text{Average\ daily\ sales}}$
  • Average daily sales: $\frac{Sales}{365}$
• Fixed asset turnover: $\frac{Net\ Sales}{Average\ Net\ Fixed\ Assets}$
• Total asset turnover: $\frac{Net\ Sales}{Average\ Total\ Assets}$

Debt Management Ratios

• Total debt to total capital: $\frac{Total\ Debt}{Total\ Debt + Total\ Equity}$
  • Indicates leverage and risk; used to compare with industry norms.
• Times Interest Earned (TIE): $\frac{EBIT}{Interest\ Expense}$
  • Measures cushion for debt payments; higher is safer.

Profitability Ratios

• Operating margin: $\frac{Operating\ Income}{Sales}$
• Profit margin: $\frac{Net\ Income}{Sales}$
• Return on Total Assets (ROA): $\frac{Net\ Income}{Total\ Assets}$
• Return on Equity (ROE): $\frac{Net\ Income}{Common\ Equity}$

Market Value Ratios

• Price-Earnings (P/E) ratio: $\frac{Market\ Price\ per\ Share}{Earnings\ per\ Share}$
• Earnings per share (EPS): $\frac{Net\ Income}{Shares\ Outstanding}$
• Market-to-Book ratio: $\frac{Market\ Price\ per\ Share}{Book\ Value\ per\ Share}$
• Book value per share: $\frac{Common\ Equity}{Shares\ Outstanding}$

How to use these ratios

• Build a complete picture by combining ratios across categories (liquidity, efficiency, leverage, profitability, market value).
• Compare to industry/peer benchmarks to identify red flags.
• Interpret trends year-over-year to detect deterioration or improvement.

Practical notes from the session

• Ratios are interrelated; debt levels affect profitability and ROE.
• For tests, watch wording (annual vs daily; not equals; etc.) and use daily conversions when needed (e.g., for DSO or daily sales).
• When solving problems, remember to use averages where required (e.g., average assets) and apply the correct denominator (e.g., 365 for daily figures).

Quick reminders for exam prep

• Focus on definitions, standard formulas, and typical interpretations.
• Practice with reverse-engineering problems from the formulas to ensure familiarity.
• Be comfortable switching between terms (e.g., turnover vs. rate vs. ratio).