Financial Ratios - Comprehensive Notes (25 Ratios + 1 Bonus)

Financial Statements and Ratio Analysis: Key Concepts

• Financial statements are the source for ratio calculations. The three main statements are: Income Statement, Balance Sheet, and Cash Flow Statement. In practice, most Financial Ratios can be calculated using just the Income Statement and the Balance Sheet.

• Financial statements definitions:

  • Income Statement: summary of revenues and expenses over a period of time.

  • Balance Sheet: snapshot of assets, liabilities, and equity at a point in time.

• What is a Financial Ratio?

  • A ratio compares the size of one line item to another, usually from the Income Statement or Balance Sheet.

  • Ratios are often expressed as percentages; when so, we multiply by 100.

• Purpose of Financial Ratio Analysis:

  • Compare ratios over time (trend analysis) and across different businesses (benchmarking).

• Five main groups of ratios:

  • Profitability Ratios

  • Liquidity Ratios

  • Efficiency Ratios

  • Leverage Ratios

  • Price Ratios

• Note on sources and study aids:

  • Profitability, Liquidity, Efficiency, Leverage, and Price Ratios each have common formulas and interpretations.

  • The creator offers Cheat Sheets on the website to summarize these ratios.

  • When comparing ratios over time, consider the effect of different fiscal periods and one-time items.

• Important general formula note:

  • A ratio is typically written as the ratio of one financial statement line item to another, and then expressed as a percentage when appropriate.

  • For time-series comparisons, use consistent periods and, when comparing with the Balance Sheet, consider using average Balance Sheet figures to account for the snapshot-vs-period nature of the statements.

Five Groups of Financial Ratios

• Profitability Ratios

• Liquidity Ratios

• Efficiency Ratios

• Leverage Ratios

• Price Ratios

• These groups help organize the 25 (plus bonus) ratios the video covers.

• Profitability Ratios measure how efficiently a business generates profit from revenue, assets, equity, and capital employed.

• Margin Ratios measure how well a business converts revenue into profit; Return Ratios measure how profit relates to the investment base (assets, equity, or capital employed).

• Profitability Step-By-Step:

  • Revenue is on the top line of the Income Statement; Profit is the financial gain left after expenses.

  • There are three types of profit on the Income Statement: Gross Profit, Operating Profit, and Net Profit.

  • Gross Profit = Revenue wdash Cost of Sales. Gross Profit Margin = $\frac{Gross\ Profit}{Revenue}$ (e.g., if Gross Profit is $\$500,000$ and Revenue is $\$1,000,000$, then Gross Profit Margin = $50\%$).

  • Operating Profit is Gross Profit minus Operating Expenses. Operating Profit Margin = $\frac{Operating\ Profit}{Revenue}$ (e.g., if Operating Profit is $\$300,000$ and Revenue is $\$1,000,000$, then Operating Profit Margin = $30\%$).

  • Net Profit is the bottom line after all expenses. Net Profit Margin = $\frac{Net\ Profit}{Revenue}$ (e.g., if Net Profit is $\$150,000$ and Revenue is $\$1,000,000$, then Net Profit Margin = $15\%$).

• Return Ratios (part of Profitability):

  • These use Net Profit relative to asset/equity/capital employed.

  • ROA (Return on Assets) = $\frac{Net\ Profit}{Total\ Assets}$ (e.g., if Net Profit is $\$150,000$ and Total Assets are $\$750,000$, then ROA = $20\%$).

  • ROE (Return on Equity) = $\frac{Net\ Profit}{Total\ Equity}$ (e.g., if Net Profit is $\$150,000$ and Total Equity is $\$300,000$, then ROE = $50\%$).

  • ROCE (Return on Capital Employed) = $\frac{Net\ Profit}{Capital\ Employed}$ (e.g., if Net Profit is $\$150,000$ and Capital Employed is $\$600,000$, then ROCE = $25\%$).

  • Capital Employed = Total Assets wdash Current Liabilities.

  • ROCE can be calculated using EBIT (Earnings Before Interest and Taxes) instead of Net Profit: $ROCE = \frac{EBIT}{Capital\ Employed}$ (e.g., if EBIT is $\$200,000$ and Capital Employed is $\$600,000$, then ROCE = $33.33\%$).

  • Important caveat: Leverage can inflate ROE when a business takes on large loans. Capital employed (which excludes long-term debt used to fund operations) can give a clearer view of efficiency with respect to the funded base.

• Liquidity Ratios

  • Purpose: ability to cover short-term obligations with liquid assets.

  • Key liquidity ratios ( Balance Sheet items ): cash, marketable securities, accounts receivable, inventory, and prepaid expenses.

  • The most liquid assets are cash; not all current assets are equally liquid (inventory and prepaid expenses are not as liquid).

  • Formulas:

  • Cash Ratio: $\text{Cash Ratio} = \frac{Cash}{Current\ Liabilities}$ (e.g., if Cash is $\$50,000$ and Current Liabilities are $\$100,000$, then Cash Ratio = $0.5$).

  • Quick Ratio (Acid Test): includes the most liquid assets: cash, marketable securities, and accounts receivable. $\text{Quick Ratio} = \frac{Cash + Marketable\ Securities + Accounts\ Receivable}{Current\ Liabilities}$ (e.g., if Cash is $\$50,000$, Marketable Securities is $\$20,000$, Accounts Receivable is $\$30,000$ and Current Liabilities are $\$100,000$, then Quick Ratio = $1.0$).

  • Current Ratio: broader measure using all current assets. $\text{Current Ratio} = \frac{Current\ Assets}{Current\ Liabilities}$ (e.g., if Current Assets are $\$200,000$ and Current Liabilities are $\$100,000$, then Current Ratio = $2.0$).

  • Interpretation notes:

  • Cash Ratio > 1 indicates ability to cover short-term debt with cash alone, but this is not always practical.

  • Quick Ratio provides a stricter view of liquidity than the Current Ratio by excluding less liquid current assets.

• Efficiency Ratios

• Purpose: measure how effectively a business uses its assets and manages its working capital.

• Turnover Ratios (subset of Efficiency):

  • Inventory Turnover = $\frac{COGS}{Inventory}$ (e.g., with $\$600,000$ COGS and $\$100,000$ Inventory, Inventory Turnover is $6$ times, meaning inventory sold $6$ times per period).

  • Receivables Turnover = $\frac{Revenue}{Accounts\ Receivable}$ (e.g., if Revenue is $\$1,000,000$ and Accounts Receivable is $\$250,000$, then Receivables Turnover = $4$ times).

  • Asset Turnover = $\frac{Revenue}{Total\ Assets}$ (e.g., if Revenue is $\$1,000,000$ and Total Assets are $\$750,000$, then Asset Turnover = $1.33$ times).

  • Payables Turnover = $\frac{COGS}{Accounts\ Payable}$ (e.g., if COGS is $\$600,000$ and Accounts Payable is $\$120,000$, then Payables Turnover = $5$ times).

• Cash Conversion Cycle (CCC): measures the average days to convert investments in inventory into cash.

  • CCC = DSI + DSO + DPO, where these are the three components below.

  • Days Sales of Inventory (DSI): the inverse of Inventory Turnover, expressed in days.

  • Formula variants: $DSI = \frac{Inventory}{COGS} \times 365$ or equivalently $DSI = \frac{365}{Inventory\ Turnover}$ (e.g., if Inventory Turnover is $6$, then DSI = $365 / 6 \approx 60.8$ days).

  • Days Sales Outstanding (DSO): inverse of Receivables Turnover, expressed in days.

  • Formula: $DSO = \frac{Accounts\ Receivable}{Revenue} \times 365$ or $DSO = \frac{365}{Receivables\ Turnover}$ (e.g., if Receivables Turnover is $4$, then DSO = $365 / 4 \approx 91.25$ days).

  • Days Payable Outstanding (DPO): the average number of days to pay suppliers.

  • Formula: $DPO = \frac{Accounts\ Payable}{COGS} \times 365$ (e.g., if Payables Turnover is $5$, then DPO = $365 / 5 \approx 73$ days).

  • CCC interpretation: a lower CCC indicates quicker conversion of investments into cash; CCC complements Turnover Ratios (e.g., if DSI=60.8, DSO=91.25, DPO=73, then CCC = $60.8 + 91.25 - 73 = 79.05$ days).

• Leverage Ratios

• Leverage is about debt and risk; ratios split into Balance Sheet and Income Statement measures.

• Balance Sheet Leverage Ratios:

  • Debt to Assets (DTA) = $\frac{Total\ Liabilities}{Total\ Assets}$ (e.g., if Total Liabilities are $\$450,000$ and Total Assets are $\$750,000$, then DTA = $0.6$ or $60\%$, indicating $60\%$ of assets are debt-financed).

  • Debt to Equity (DTE) = $\frac{Total\ Liabilities}{Total\ Equity}$ (e.g., if Total Liabilities are $\$450,000$ and Total Equity is $\$300,000$, then DTE = $1.5$).

• Interest Ratios (related to leverage):

  • Interest Coverage Ratio = $\frac{Operating\ Profit}{Interest\ Expenses}$ (e.g., if Operating Profit is $\$300,000$ and Interest Expenses are $\$50,000$, then Interest Coverage = $6$ times).

  • A business can also be analyzed using DSCR (Debt Service Coverage Ratio):

• Debt Service Coverage Ratio (DSCR)

  • DSCR = $\frac{EBITDA}{Total\ Debt\ Service}$ (e.g., if EBITDA is $\$350,000$ and Total Debt Service is $\$100,000$, then DSCR = $3.5$).

  • Total Debt Service = interest payments + principal repayments (including the current portion of long-term debt).

  • EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization (non-cash expenses removed). $EBITDA = EBIT + Depreciation + Amortization$ (e.g., if EBIT is $\$200,000$, Depreciation is $\$100,000$, and Amortization is $\$50,000$, then EBITDA = $\$350,000$).

  • Note: Using EBITDA in DSCR helps assess the ability to service debt excluding non-cash charges.

• Price Ratios

• Price-based measures used by investors to evaluate share price relative to earnings or cash flows.

• Earnings-based ratios:

  • Earnings per Share (EPS) = $EPS = \frac{Net\ Profit - Preferred\ Dividends}{Common\ Shares\ Outstanding}$ (e.g., if Net Profit is $\$150,000$, no Preferred Dividends, and Common Shares Outstanding are $100,000$, then EPS = $\$1.50$).

  • Net Profit appears on the bottom line; preferred dividends may be subtracted before dividing by common shares.

  • Common shares outstanding are found in the Equity section of the Balance Sheet (note or line item).

  • Price-to-Earnings (P/E) Ratio = $\frac{Share\ Price}{EPS}$ (e.g., if Share Price is $\$15$ and EPS is $\$1.50$, P/E Ratio = $10x$).

  • Share price is the market price per share; can be found online or on stock exchanges.

  • A high P/E may reflect expected strong future growth but can indicate overvaluation.

  • PEG Ratio = $\frac{P/E}{EPS\ Growth}$ (e.g., if P/E is $10$ and EPS Growth is $15\%$ (or $0.15$), then PEG Ratio = $0.67$).

  • EPS Growth is the projected annual growth rate in EPS and is an estimate; PEG adjusts P/E for growth expectations.

• Dividend-based ratios:

  • Dividends per Share (DPS) = $\frac{Dividends\ Paid}{Common\ Shares\ Outstanding}$ (e.g., if Dividends Paid amount to $\$50,000$ to $100,000$ shares, then DPS = $\$0.50$).

  • Special dividends should be deducted when calculating DPS because they are non-recurring.

  • Dividend Yield = $\frac{DPS}{Share\ Price}$ (e.g., if DPS is $\$0.50$ and Share Price is $\$15$, then Dividend Yield = $3.33\%$).

  • Dividend Payout Ratio (bonus 26th ratio): $\frac{Dividends\ Paid}{Net\ Profit}$ (e.g., if Dividends Paid are $\$50,000$ and Net Profit is $\$150,000$, then Dividend Payout = $33.33\%$).

  • Dividend-focused measures help investors understand current income versus growth expectations.

• Summary of the 26 ratios mentioned (25 core ratios + 1 bonus):

  • Profitability: Gross Margin, Operating Margin, Net Margin; ROA, ROE, ROCE (and alternatives using EBIT).

  • Liquidity: Cash Ratio, Quick Ratio, Current Ratio.

  • Efficiency: Inventory Turnover, Receivables Turnover, Asset Turnover, Payables Turnover; CCC and its components (DSI, DSO, DPO).

  • Leverage: DTA, DTE, Interest Coverage, DSCR.

  • Price: EPS, P/E, PEG, DPS, Dividend Yield, Dividend Payout.

• Practical and interpretive takeaways:

  • Use average Balance Sheet figures when comparing with Income Statement-based ratios (to account for the time period vs snapshot nature of Balance Sheet).

  • Leverage can distort ROE; ROCE provides a view relative to capital employed (assets wdash current liabilities).

  • EBITDA-based DSCR excludes non-cash expenses and can be useful for debt servicing analysis.

  • EPS growth is an estimate; PEG should be interpreted with caution when growth assumptions are uncertain.

  • Special dividends affect DPS calculations and should be treated accordingly.

  • The cheat sheets mentioned are available on the creator's website; profits finance the channel and may help with study planning.

Key Formulas (summary for quick revision)

• Profit Margin (Margin Ratios):

  • Gross Profit Margin = $\frac{Gross\ Profit}{Revenue}$ (e.g., if Gross Profit is $\$500,000$ and Revenue is $\$1,000,000$, then $50\%$)

  • Operating Profit Margin = $\frac{Operating\ Profit}{Revenue}$ (e.g., if Operating Profit is $\$300,000$ and Revenue is $\$1,000,000$, then $30\%$)

  • Net Profit Margin = $\frac{Net\ Profit}{Revenue}$ (e.g., if Net Profit is $\$150,000$ and Revenue is $\$1,000,000$, then $15\%$)

• Return Ratios:

  • ROA = $\frac{Net\ Profit}{Total\ Assets}$ (use average assets when comparing to income statement; e.g., if Net Profit is $\$150,000$ and Total Assets are $\$750,000$, then $20\%$)

  • ROE = $\frac{Net\ Profit}{Total\ Equity}$ (can be inflated by high debt; e.g., if Net Profit is $\$150,000$ and Total Equity is $\$300,000$, then $50\%$)

  • ROCE = $\frac{Net\ Profit}{Capital\ Employed}$; Capital Employed = $Total\ Assets - Current\ Liabilities$ (e.g., if Net Profit is $\$150,000$ and Capital Employed is $\$600,000$, then $25\%$)

  • ROCE (alternative) = $\frac{EBIT}{Capital\ Employed}$ (e.g., if EBIT is $\$200,000$ and Capital Employed is $\$600,000$, then $33.33\%$)

• Liquidity:

  • Cash Ratio = $\frac{Cash}{Current\ Liabilities}$ (e.g., if Cash is $\$50,000$ and Current Liabilities are $\$100,000$, then $0.5$)

  • Quick Ratio = $\frac{Cash + Marketable\ Securities + Accounts\ Receivable}{Current\ Liabilities}$ (e.g., if Cash is $\$50,000$, Marketable Securities is $\$20,000$, Accounts Receivable is $\$30,000$ and Current Liabilities are $\$100,000$, then $1.0$)

  • Current Ratio = $\frac{Current\ Assets}{Current\ Liabilities}$ (e.g., if Current Assets are $\$200,000$ and Current Liabilities are $\$100,000$, then $2.0$)

• Efficiency / Turnover:

  • Inventory Turnover = $\frac{COGS}{Inventory}$ (e.g., with $\$600,000$ COGS and $\$100,000$ Inventory, then $6$ times)

  • Receivables Turnover = $\frac{Revenue}{Accounts\ Receivable}$ (e.g., if Revenue is $\$1,000,000$ and Accounts Receivable is $\$250,000$, then $4$ times)

  • Asset Turnover = $\frac{Revenue}{Total\ Assets}$ (e.g., if Revenue is $\$1,000,000$ and Total Assets are $\$750,000$, then $1.33$ times)

  • Payables Turnover = $\frac{COGS}{Accounts\ Payable}$ (e.g., if COGS is $\$600,000$ and Accounts Payable is $\$120,000$, then $5$ times)

• CCC and components:

  • DSI = $DSI = \frac{Inventory}{COGS} \times 365 = \frac{365}{Inventory\ Turnover}$ (e.g., if Inventory Turnover is $6$, then $\approx 60.8$ days)

  • DSO = $DSO = \frac{Accounts\ Receivable}{Revenue} \times 365 = \frac{365}{Receivables\ Turnover}$ (e.g., if Receivables Turnover is $4$, then $\approx 91.25$ days)

  • DPO = $DPO = \frac{Accounts\ Payable}{COGS} \times 365$ (e.g., if Payables Turnover is $5$, then $\approx 73$ days)

  • CCC = $CCC = DSI + DSO + DPO$ (e.g., if DSI=60.8, DSO=91.25, DPO=73, then CCC = $60.8 + 91.25 - 73 = 79.05$ days)

• Leverage:

  • DTA = $\frac{Total\ Liabilities}{Total\ Assets}$ (e.g., if Total Liabilities are $\$450,000$ and Total Assets are $\$750,000$, then $0.6$ or $60\%$)

  • DTE = $\frac{Total\ Liabilities}{Total\ Equity}$ (e.g., if Total Liabilities are $\$450,000$ and Total Equity is $\$300,000$, then $1.5$)

  • Interest Coverage = $\frac{Operating\ Profit}{Interest\ Expenses}$ (e.g., if Operating Profit is $\$300,000$ and Interest Expenses are $\$50,000$, then $6$ times)

  • DSCR = $\frac{EBITDA}{Total\ Debt\ Service}$, Total Debt Service = interest + principal repayments (e.g., if EBITDA is $\$350,000$ and Total Debt Service is $\$100,000$, then $3.5$)

  • EBITDA = $EBITDA = EBIT + Depreciation + Amortization$ (e.g., if EBIT is $\$200,000$, Depreciation is $\$100,000$, and Amortization is $\$50,000$, then $\$350,000$)

• Price:

  • EPS = $EPS = \frac{Net\ Profit - Preferred\ Dividends}{Common\ Shares\ Outstanding}$ (e.g., if Net Profit is $\$150,000$, no Preferred Dividends, and Common Shares Outstanding are $100,000$, then $\$1.50$)

  • P/E Ratio = $\frac{Share\ Price}{EPS}$ (e.g., if Share Price is $\$15$ and EPS is $\$1.50$, then $10x$)

  • PEG Ratio = $\frac{P/E}{EPS\ Growth}$ (e.g., if P/E is $10$ and EPS Growth is $15\%$, then $0.67$)

  • DPS = $\frac{Dividends\ Paid}{Common\ Shares\ Outstanding}$ (special dividends excluded; e.g., if Dividends Paid are $\$50,000$ for $100,000$ shares, then $\$0.50$)

  • Dividend Yield = $\frac{DPS}{Share\ Price}$ (e.g., if DPS is $\$0.50$ and Share Price is $\$15$, then $3.33\%$)

  • Dividend Payout = $\frac{Dividends\ Paid}{Net\ Profit}$ (e.g., if Dividends Paid are $\$50,000$ and Net Profit is $\$150,000$, then $33.33\%$)

• Notes:
  -EPS Growth is an estimate; PEG depends on that forecast.
  -The Balance Sheet provides the funding base for leverage ratios; the Income Statement provides the profit base for profitability and efficiency metrics.
  -Cheat Sheets are linked in the video description for quick reference.

References and study aids

• Cheat Sheets: available on the creator's website (link in video description).

• Subscribe for deeper dives into each ratio in the playlist (Profitability, Liquidity, Efficiency, Leverage, Price).

• Practical takeaway: use these tools to compare performance across time and across peers, while understanding the limitations and the context of each ratio.