Financial Ratio Cheatsheet

Financial Ratio Cheatsheet
MyAccountingCourse.com
PDF
Table of contents
Liquidity Ratios 3
Solvency Ratios 8
Efficiency Ratios 12
Profitability Ratios 17
Market Prospect Ratios 23
Coverage Ratios 28
CPA Exam Ratios to Know 31
CMA Exam Ratios to Know 32
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This is a quick financial ratio cheatsheet with short explanations,
formulas, and analyzes of some of the most common financial
ratios. Check out www.myaccountingcourse.com/financial-ratios/
for more ratios, examples, and explanations.
Liquidity Ratios
Quick Ratio / Acid Test Ratio

Current Ratio
Working Capital Ratio
Times Interest Earned
Find more Liquidity Ratios

on the myaccountingcourse.com financial ratios page.
Copyright © MyAccountingCourse.com | For personal use by the original purchaser only - financial ratio cheatsheet - page 3
Quick Ratio
Explanation
-The quick ratio or acid test ratio is a liquid- -The quick ratio is often called the acid
ity ratio that measures the ability of a com- test ratio in reference to the historical use
pany to pay its current liabilities when they of acid to test metals for gold by the early
come due with only quick assets. Quick miners. If the metal passed the acid test, it
assets are current assets that can be con- was pure gold. If metal failed the acid test
verted to cash within 90 days or in the by corroding from the acid, it was a base
short-term. Cash, cash equivalents, short- metal and of no value.
term investments or marketable securities,
and current accounts receivable are con- The acid test of finance shows how well
sidered quick assets. a company can quickly convert its assets
into cash in order to pay off its current li-
abilities. It also shows the level of quick as-
sets to current liabilities.
Formula
Analysis
-The acid test ratio measures the liquidity -Higher quick ratios are more favorable
of a company by showing its ability to pay for companies because it shows there are
off its current liabilities with quick assets. If more quick assets than current liabilities. A
a firm has enough quick assets to cover its company with a quick ratio of 1 indicates
total current liabilities, the firm will be able that quick assets equal current assets. This
to pay off its obligations without having to also shows that the company could pay
sell off any long-term or capital assets. off its current liabilities without selling any
long-term assets. An acid ratio of 2 shows
Since most businesses use their long-term that the company has twice as many
assets to generate revenues, selling off quick assets than current liabilities.
these capital assets will not only hurt the
company it will also show investors that
current operations aren’t making enough
profits to pay off current liabilities.
Check out more examples

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Current Ratio
Explanation
-The current ratio is a liquidity and efficien- be converted into cash in the short term.
cy ratio that measures a firm’s ability to This means that companies with larger
pay off its short-term liabilities with its cur- amounts of current assets will more easily
rent assets. The current ratio is an impor- be able to pay off current liabilities when
tant measure of liquidity because short- they become due without having to sell
term liabilities are due within the next year. off long-term, revenue generating assets.
This means that a company has a limited

amount of time in order to raise the funds
to pay for these liabilities. Current assets
like cash, cash equivalents, and market-
able securities can easily
Formula
Analysis
-The current ratio helps investors and credi- -If a company has to sell of fixed assets
tors understand the liquidity of a company to pay for its current liabilities, this usually
and how easily that company will be able means the company isn’t making enough
to pay off its current liabilities. This ratio ex- from operations to support activities. In
presses a firm’s current debt in terms of other words, the company is losing money.
current assets. So a current ratio of 4 would Sometimes this is the result of poor collec-
mean that the company has 4 times more tions of accounts receivable.
current assets than current liabilities.
The current ratio also sheds light on the
A higher current ratio is always more favor- overall debt burden of the company. If a
able than a lower current ratio because it company is weighted down with a current
shows the company can more easily make debt, its cash flow will suffer.
current debt payments.

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Working Capital Ratio
Explanation
-The working capital ratio, also called the The faster the assets can be converted
current ratio, is a liquidity ratio that mea- into cash, the more likely the company will
sures a firm’s ability to pay off its current have the cash in time to pay its debts.
liabilities with current assets. The working
capital ratio is important to creditors be- The reason this ratio is called the working
cause it shows the liquidity of the capital ratio comes from the working capi-
company. tal calculation. When current assets
exceed current liabilities, the firm has
Current liabilities are best paid with cur- enough capital to run its day-to-day op-
rent assets like cash, cash equivalents, erations. In other words, it has even capital
and marketable securities because these to work. The working capital ratio trans-
assets can be converted into cash much forms the working capital calculation into
quicker than fixed assets. a comparison between current assets and
current liabilities.
Formula
Analysis
-Since the working capital ratio measures A ratio less than 1 is considered risky by
current assets as a percentage of current creditors and investors because it shows
liabilities, it would only make sense that a the company isn’t running efficiently and
higher ratio is more favorable. A WCR of 1 can’t cover its current debt properly. A ra-
indicates the current assets equal current tio less than 1 is always a bad thing and
liabilities. A ratio of 1 is usually considered is often referred to as negative working
the middle ground. It’s not risky, but it is capital.
also not very safe. This means that the firm
would have to sell all of its current assets in On the other hand, a ratio above 1 shows
order to pay off its current liabilities. outsiders that the company can pay all of
its current liabilities and still have current
assets left over or positive working capital.

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Times Interest Earned Ratio
Explanation
-The times interest earned ratio, sometimes Since these interest payments are usually
called the interest coverage ratio, is a cov- made on a long-term basis, they are often
erage ratio that measures the proportion- treated as an ongoing, fixed expense. As
ate amount of income that can be used with most fixed expenses, if the company
to cover interest expenses in the future. can’t make the payments, it could go
bankrupt and cease to exist. Thus, this ratio
In some respects the times interest ratio could be considered a solvency ratio.
is considered a solvency ratio because it
measures a firm’s ability to make interest
and debt service payments.
Formula
Analysis
-The times interest ratio is stated in num- As you can see, creditors would favor a
bers as opposed to a percentage. The ra- company with a much higher times inter-
tio indicates how many times a company est ratio because it shows the company
could pay the interest with its before tax can afford to pay its interest payments
income, so obviously the larger ratios are when they come due. Higher ratios are less
considered more favorable than smaller risky while lower ratios indicate credit risk.
ratios.
In other words, a ratio of 4 means that a

company makes enough income to pay
for its total interest expense 4 times over.
Said another way, this company’s income
is 4 times higher than its interest expense
for the year.

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Solvency Ratios
Debt to Equity Ratio

Equity Ratio
Debt Ratio
Find more Solvency Ratios

Debt to Equity Ratio
Explanation
-The debt to equity ratio is a financial, li- - Each industry has different debt to equity
quidity ratio that compares a company’s ratio benchmarks, as some industries tend
total debt to total equity. The debt to eq- to use more debt financing than others. A
uity ratio shows the percentage of com- debt ratio of .5 means that there are half
pany financing that comes from creditors as many liabilities than there is equity. In
and investors. A higher debt to equity ra- other words, the assets of the company
tio indicates that more creditor financing are funded 2-to-1 by investors to creditors.
(bank loans) is used than investor financ- This means that investors own 66.6 cents of
ing (shareholders). every dollar of company assets while cred-
itors only own 33.3 cents on the dollar.
A debt to equity ratio of 1 would means

that investors and creditors have an equal
stake in the business assets.
Formula
Analysis
-A lower debt to equity ratio usually im- Creditors view a higher debt to equity ratio
plies a more financially stable business. as risky because it shows that the investors
Companies with a higher debt to equity haven’t funded the operations as much
ratio are considered more risky to credi- as creditors have. In other words, investors
tors and investors than companies with a don’t have as much skin in the game as
lower ratio. Unlike equity financing, debt the creditors do. This could mean that in-
must be repaid to the lender. Since debt vestors don’t want to fund the business op-
financing also requires debt servicing or erations because the company isn’t per-
regular interest payments, debt can be a forming well. Lack of performance might
far more expensive form of financing than also be the reason why the company is
equity financing. Companies leveraging seeking out extra debt financing.forming
large amounts of debt might not be able well. Lack of performance might also be
to make the payments. the reason why the company is seeking
out extra debt financing.

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Equity Ratio
Explanation
-The equity ratio is an investment leverage The second component inversely shows
or solvency ratio that measures the amount how leveraged the company is with debt.
of assets that are financed by owners’ in- The equity ratio measures how much of a
vestments by comparing the total equity in firm’s assets were financed by investors.
the company to the total assets. In other words, this is the investors’ stake
in the company. This is what they are on
The equity ratio highlights two important fi- the hook for. The inverse of this calcula-
nancial concepts of a solvent and sustain- tion shows the amount of assets that were
able business. The first component shows financed by debt. Companies with higher
how much of the total company assets are equity ratios show new investors and credi-
owned outright by the investors. In other tors that investors believe in the company
words, after all of the liabilities are paid off, and are willing to finance it with their in-
the investors will end up with the remaining vestments.
assets.
Formula
Analysis
-In general, higher equity ratios are typi- Equity financing in general is much cheap-
cally favorable for companies. This is usu- er than debt financing because of the in-
ally the case for several reasons. Higher terest expenses related to debt financing.
investment levels by shareholders shows Companies with higher equity ratios should
potential shareholders that the company have less financing and debt service costs
is worth investing in since so many inves- than companies with lower ratios.
tors are willing to finance the company. A
higher ratio also shows potential creditors As with all ratios, they are contingent on
that the company is more sustainable and the industry. Exact ratio performance de-
less risky to lend future loans. pends on industry standards and bench-
marks.

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Debt Ratio
Explanation
-Debt ratio is a solvency ratio that mea- This ratio measures the financial leverage
sures a firm’s total liabilities as a percent- of a company. Companies with higher lev-
age of its total assets. In a sense, the debt els of liabilities compared with assets are
ratio shows a company’s ability to pay off considered highly leveraged and more
its liabilities with its assets. In other words, risky for lenders.
this shows how many assets the company
must sell in order to pay off all of its liabili- This helps investors and creditors analysis
ties. the overall debt burden on the company
as well as the firm’s ability to pay off the
debt in future, uncertain economic times.
Formula
Analysis
-The debt ratio is shown in decimal format A debt ratio of .5 is often considered to be
because it calculates total liabilities as a less risky. This means that the company has
percentage of total assets. As with many twice as many assets as liabilities. Or said
solvency ratios, a lower ratios is more fa- a different way, this company’s liabilities
vorable than a higher ratio. are only 50 percent of its total assets. Es-
sentially, only its creditors own half of the
A lower debt ratio usually implies a more company’s assets and the shareholders
stable business with the potential of lon- own the remainder of the assets.
gevity because a company with lower ra-
tio also has lower overall debt. Each indus- A ratio of 1 means that total liabilities
try has its own benchmarks for debt, but .5 equals total assets. In other words, the
is reasonable ratio. company would have to sell off all of its
assets in order to pay off its liabilities. Obvi-
ously, this is a highly leverage firm.

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Efficiency Ratios
Accounts Receivable Turnoverr

Asset Turnover Ratio
Inventory Turnover Ratio
Days’ Sales in Inventory
Find more Efficiency Ratios

Acccounts Receivable Turnover
Explanation
-What is accounts receivable? It’s an effi- during the year and collected $40,000 of
ciency ratio or activity ratio that measures receivables during the year, the company
how many times a business can turn its ac- would have turned its accounts receiv-
counts receivable into cash during a pe- able twice because it collected twice the
riod. In other words, the accounts receiv- amount of average receivables.
able turnover ratio measures how many
times a business can collect its average This ratio shows how efficient a company is
accounts receivable during the year. at collecting its credit sales from customers.
Some companies collect their receivables
A turn refers to each time a company col- from customers in 90 days while other take
lects its average receivables. If a compa- up to 6 months to collect from customers.
ny had $20,000 of average receivables
Formula
Analysis
-Since the receivables turnover ratio mea- Higher efficiency is favorable from a cash
sures a business’ ability to efficiently col- flow standpoint as well. If a company can
lect its receivables, it only makes sense collect cash from customers sooner, it will
that a higher ratio would be more favor- be able to use that cash to pay bills and
able. Higher ratios mean that companies other obligations sooner.
are collecting their receivables more fre-
quently throughout the year. For instance, Accounts receivable turnover also is and
a ratio of 2 means that the company col- indication of the quality of credit sales and
lected its average receivables twice dur- receivables. A company with a higher ra-
ing the year. In other words, this company tio shows that credit sales are more likely
is collecting is money from customers ev- to be collected than a company with a
ery six months. lower ratio. Since accounts receivable are
often posted as collateral for loans, quality
of receivables is important.

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Asset Turnover Ratio
Explanation
-The asset turnover ratio is an efficiency This ratio measures how efficiently a firm
ratio that measures a company’s ability to uses its assets to generate sales, so a higher
generate sales from its assets by compar- ratio is always more favorable. Higher turn-
ing net sales with average total assets. In over ratios mean the company is using its
other words, this ratio shows how efficiently assets more efficiently. Lower ratios mean
a company can use its assets to generate that the company isn’t using its assets effi-
sales. ciently and most likely have management
or production problems.
The total asset turnover ratio calculates net
sales as a percentage of assets to show
how many sales are generated from each
dollar of company assets. For instance, a
ratio of .5 means that each dollar of assets
generates 50 cents of sales.
Formula
Analysis
-For instance, a ratio of 1 means that the The total asset turnover ratio is a general
net sales of a company equals the aver- efficiency ratio that measures how effi-
age total assets for the year. In other words, ciently a company uses all of its assets. This
the company is generating 1 dollar of sales gives investors and creditors an idea of
for every dollar invested in assets. how a company is managed and uses its
assets to produce products and sales.
Like with most ratios, the asset turnover ra-
tio is based on industry standards. Some Sometimes investors also want to see how
industries use assets more efficiently than companies use more specific assets like
others. To get a true sense of how well a fixed assets and current assets. The fixed
company’s assets are being used, it must asset turnover ratio and the working capi-
be compared to other companies in its in- tal ratio are turnover ratios similar to the
dustry. asset turnover ratio that are often used
to calculate the efficiency of these asset
classes.

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Inventory Turnover Ratio
Explanation
-The inventory turnover ratio is an efficien- This ratio is important because total turn-
cy ratio that shows how effectively inven- over depends on two main components
tory is managed by comparing cost of of performance. The first component is
goods sold with average inventory for a stock purchasing. If larger amounts of in-
period. This measures how many times av- ventory are purchased during the year, the
erage inventory is “turned” or sold during company will have to sell greater amounts
a period. In other words, it measures how of inventory to improve its turnover. If the
many times a company sold its total av- company can’t sell these greater amounts
erage inventory dollar amount during the of inventory, it will incur storage costs and
year. A company with $1,000 of average other holding costs.
inventory and sales of $10,000 effectively
sold its 10 times over. The second component is sales. Sales
have to match inventory purchases other-
wise the inventory will not turn effectively.
Formula
Analysis
-Inventory turnover is a measure of how If this inventory can’t be sold, it is worthless
efficiently a company can control its mer- to the company. This measurement shows
chandise, so it is important to have a high how easily a company can turn its inven-
turn. This shows the company does not tory into cash.
overspend by buying too much inventory
and wastes resources by storing non-sal- Creditors are particularly interested in this
able inventory. It also shows that the com- because inventory is often put up as col-
pany can effectively sell the inventory it lateral for loans. Banks want to know that
buys. this inventory will be easy to sell.
This measurement also shows investors Inventory turns vary with industry. For in-
how liquid a company’s inventory is. Think stance, the apparel industry will have high-
about it. Inventory is one of the biggest as- er turns than the exotic car industry.
sets a retailer reports on its balance sheet.

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Days’ Sales in Inventory
Explanation
-The days sales in inventory calculation, Both investors and creditors want to know
also called days inventory outstanding how valuable a company’s inventory is.
or simply days in inventory, measures the Older, more obsolete inventory is always
number of days it will take a company to worth less than current, fresh inventory. The
sell all of its inventory. In other words, the days sales in inventory shows how fast the
days sales in inventory ratio shows how company is moving its inventory. In other
many days a company’s current stock of words, it shows how fresh the inventory is.
inventory will last.
This calculation also shows the liquidity of
This is an important to creditors and inves- inventory. Shorter days inventory outstand-
tors for three main reasons. It measures ing means the company can convert its
value, liquidity, and cash flows. inventory into cash sooner. In other words,
the inventory is extremely liquid.
Formula
Analysis
-The days sales in inventory is a key com- Management strives to only buy enough
ponent in a company’s inventory man- inventories to sell within the next 90 days.
agement. Inventory is a expensive for a If inventory sits longer than that, it can start
company to keep, maintain, and store. costing the company extra money.
Companies also have to be worried about
protecting inventory from theft and obso- It only makes sense that lower days inven-
lescence. tory outstanding is more favorable than
higher ratios.
Management wants to make sure its inven-
tory moves as fast as possible to minimize
these costs and to increase cash flows.
Remember the longer the inventory sits
on the shelves, the longer the company’s
cash can’t be used for other operations.

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Profitability Ratios
Gross Margin Ratio

Profit Margin Ratio
Return on Assets
Return on Capital Employed
Return on Equity

Gross Margin Ratio
Explanation
-Gross margin ratio is a profitability ratio Gross margin ratio is often confused with
that compares the gross margin of a busi- the profit margin ratio, but the two ratios
ness to the net sales. This ratio measures are completely different. Gross margin ra-
how profitable a company sells its inven- tio only considers the cost of goods sold
tory or merchandise. In other words, the in its calculation because it measures the
gross profit ratio is essentially the percent- profitability of selling inventory. Profit mar-
age markup on merchandise from its cost. gin ratio on the other hand considers other
This is the pure profit from the sale of inven- expenses.
tory that can go to paying operating ex-
penses.
Formula
Analysis
-Gross margin ratio is a profitability ratio The second way retailers can achieve a
that measures how profitable a company high ratio is by marking their goods up high-
can sell its inventory. It only makes sense er. This obviously has to be done competi-
that higher ratios are more favorable. tively otherwise goods will be too expen-
Higher ratios mean the company is selling sive and customers will shop elsewhere.
their inventory at a higher profit percent-
age. A company with a high gross margin ratios
mean that the company will have more
High ratios can typically be achieved by money to pay operating expenses like
two ways. One way is to buy inventory very salaries, utilities, and rent. Since this ratio
cheap. If retailers can get a big purchase measures the profits from selling inventory,
discount when they buy their inventory it also measures the percentage of sales
from the manufacturer or wholesaler, their that can be used to help fund other parts
gross margin will be higher because their of the business. Here is another great ex-
costs are down. plaination.

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Profit Margin Ratio
Explanation Investors want to make sure profits are
-The profit margin ratio, also called the re- high enough to distribute dividends while
turn on sales ratio or gross profit ratio, is a creditors want to make sure the company
profitability ratio that measures the amount has enough profits to pay back its loans.
of net income earned with each dollar of In other words, outside users want to know
sales generated by comparing the net that the company is running efficiently.
income and net sales of a company. In An extremely low profit margin would indi-
other words, the profit margin ratio shows cate the expenses are too high and the
what percentage of sales are left over af- management needs to budget and cut
ter all expenses are paid by the business. expenses.
Creditors and investors use this ratio to The return on sales ratio is often used by
measure how effectively a company can internal management to set performance
convert sales into net income. goals for the future.
Formula
Analysis
-The profit margin ratio directly measures Since most of the time generating addi-
what percentage of sales is made up of tional revenues is much more difficult than
net income. In other words, it measures cutting expenses, managers generally
how much profits are produced at a cer- tend to reduce spending budgets to im-
tain level of sales. prove their profit ratio.
This ratio also indirectly measures how well Like most profitability ratios, this ratio is best
a company manages its expenses relative used to compare like sized companies in
to its net sales. That is why companies strive the same industry. This ratio is also effec-
to achieve higher ratios. They can do this tive for measuring past performance of a
by either generating more revenues why company.
keeping expenses constant or keep rev-
enues constant and lower expenses.

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Return on Assets Ratio
Explanation
-The return on assets ratio, often called the Since company assets’ sole purpose is to
return on total assets, is a profitability ratio generate revenues and produce profits,
that measures the net income produced this ratio helps both management and
by total assets during a period by compar- investors see how well the company can
ing net income to the average total assets. convert its investments in assets into profits.
In other words, the return on assets ratio or You can look at ROA as a return on invest-
ROA measures how efficiently a company ment for the company since capital assets
can manage its assets to produce profits are often the biggest investment for most
during a period. companies. In this case, the company in-
vests money into capital assets and the re-
turn is measured in profits.
Formula
Analysis
-The return on assets ratio measures how It only makes sense that a higher ratio is
effectively a company can turn earn a more favorable to investors because it
return on its investment in assets. In other shows that the company is more effective-
words, ROA shows how efficiently a com- ly managing its assets to produce greater
pany can covert the money used to pur- amounts of net income. A positive ROA ra-
chase assets into net income or profits. tio usually indicates an upward profit trend
as well. ROA is most useful for comparing
Since all assets are either funded by equity companies in the same industry as differ-
or debt, some investors try to disregard the ent industries use assets differently. For in-
costs of acquiring the assets in the return stance, construction companies use large,
calculation by adding back interest ex- expensive equipment while software com-
pense in the formula. panies use computers and servers.

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Return on Capital Employed
Explanation
-Return on capital employed or ROCE is long-term financing. This is why ROCE is a
a profitability ratio that measures how ef- more useful ratio than return on equity to
ficiently a company can generate profits evaluate the longevity of a company.
from its capital employed by comparing
net operating profit to capital employed. This ratio is based on two important calcu-
In other words, return on capital employed lations: operating profit and capital em-
shows investors how many dollars in profits ployed. Net operating profit is often called
each dollar of capital employed gener- EBIT or earnings before interest and taxes.
ates. EBIT is often reported on the income state-
ment because it shows the company prof-
ROCE is a long-term profitability ratio be- its generated from operations. EBIT can be
cause it shows how effectively assets are calculated by adding interest and taxes
performing while taking into consideration back into net income if need be.
Formula
Analysis
-The return on capital employed ratio Investors are interested in the ratio to see
shows how much profit each dollar of em- how efficiently a company uses its capital
ployed capital generates. Obviously, a employed as well as its long-term financ-
higher ratio would be more favorable being strategies. Companies’ returns should
cause it means that more dollars of profits always be high than the rate at which they
are generated by each dollar of capital are borrowing to fund the assets. If com-
employed. panies borrow at 10 percent and can only
achieve a return of 5 percent, they are
For instance, a return of .2 indicates that for loosing money.
every dollar invested in capital employed,
the company made 20 cents of profits. Just like the return on assets ratio, a com-
pany’s amount of assets can either hinder
or help them achieve a high return.

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Return on Equity Ratio
Explanation
-The return on equity ratio or ROE is a profit- This is an important measurement for po-
ability ratio that measures the ability of a tential investors because they want to see
firm to generate profits from its sharehold- how efficiently a company will use their
ers investments in the company. In other money to generate net income.
words, the return on equity ratio shows
how much profit each dollar of common ROE is also and indicator of how effective
stockholders’ equity generates. management is at using equity financing
to fund operations and grow the
So a return on 1 means that every dollar of company.
common stockholders’ equity generates 1
dollar of net income.
Formula
Analysis
-Return on equity measures how efficiently That being said, investors want to see a
a firm can use the money from sharehold- high return on equity ratio because this
ers to generate profits and grow the com- indicates that the company is using its in-
pany. Unlike other return on investment vestors’ funds effectively. Higher ratios are
ratios, ROE is a profitability ratio from the almost always better than lower ratios, but
investor’s point of view—not the compa- have to be compared to other compa-
ny. In other words, this ratio calculates how nies’ ratios in the industry. Since every in-
much money is made based on the inves- dustry has different levels of investors and
tors’ investment in the company, not the income, ROE can’t be used to compare
company’s investment in assets or some- companies outside of their industries very
thing else. effectively.

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Market Prospect Ratios
Earnings Per Share

Price Eanings P/E Ratio
Dividend Payout Ratio
Dividend Yield

Earnings Per Share
Explanation
-Earning per share, also called net income Earnings per share is also a calculation
per share, is a market prospect ratio that that shows how profitable a company is
measures the amount of net income on a shareholder basis. So a larger com-
earned per share of stock outstanding. In pany’s profits per share can be compared
other words, this is the amount of money to smaller company’s profits per share.
each share of stock would receive if all Obviously, this calculation is heavily influ-
of the profits were distributed to the out- enced on how many shares are outstand-
standing shares at the end of the year. ing. Thus, a larger company will have to
split its earning amongst many more shares
of stock compared to a smaller company.
Formula
Analysis
-Earning per share is the same as any prof- Although many investors don’t pay much
itability or market prospect ratio. Higher attention to the EPS, a higher earnings per
earnings per share is always better than a share ratio often makes the stock price of
lower ratio because this means the com- a company rise. Since so many things can
pany is more profitable and the company manipulate this ratio, investors tend to look
has more profits to distribute to its share- at it but don’t let it influence their decisions
holders. drastically.

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Price Earnings P/E Ratio
Explanation
-The price earnings ratio, often called the Companies with higher future earnings are
P/E ratio or price to earnings ratio, is a mar- usually expected to issue higher dividends
ket prospect ratio that calculates the mar- or have appreciating stock in the future.
ket value of a stock relative to its earnings
by comparing the market price per share Obviously, fair market value of a stock is
by the earnings per share. In other words, based on more than just predicted future
the price earnings ratio shows what the earnings. Investor speculation and de-
market is willing to pay for a stock based mand also help increase a share’s price
on its current earnings. over time.
Investors often use this ratio to evaluate

what a stock’s fair market value should be
by predicting future earnings per share.
Formula
Analysis
-The price to earnings ratio indicates the In general a higher ratio means that inves-
expected price of a share based on its tors anticipate higher performance and
earnings. As a company’s earnings per growth in the future. It also means that
share being to rise, so does their market companies with losses have poor PE ratios.
value per share. A company with a high
P/E ratio usually indicated positive future An important thing to remember is that this
performance and investors are willing to ratio is only useful in comparing like com-
pay more for this company’s shares. panies in the same industry. Since this ratio
is based on the earnings per share calcula-
A company with a lower ratio, on the other tion, management can easily manipulate
hand, is usually an indication of poor cur- it with specific accounting techniques.
rent and future performance. This could
prove to be a poor investment.

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Dividend Payout Ratio
Explanation
-The dividend payout ratio measures the For instance, most start up companies
percentage of net income that is distrib- and tech companies rarely give dividends
uted to shareholders in the form of divi- at all. In fact, Apple, a company formed
dends during the year. In other words, this in the 1970s, just gave its first dividend to
ratio shows the portion of profits the com- shareholders in 2012.
pany decides to keep to fund operations
and the portion of profits that is given to its Conversely, some companies want to spur
shareholders. investors’ interest so much that they are
willing to pay out unreasonably high divi-
Investors are particularly interested in the dend percentages. Inventors can see that
dividend payout ratio because they want these dividend rates can’t be sustained
to know if companies are paying out a very long because the company will even-
reasonable portion of net income to inves- tually need money for its operations.
tors.
Formula
Analysis
-Since investors want to see a steady For instance, investors can assume that
stream of sustainable dividends from a a company that has a payout ratio of 20
company, the dividend payout ratio anal- percent for the last ten years will continue
ysis is important. A consistent trend in this giving 20 percent of its profit to the share-
ratio is usually more important than a high holders.
or low ratio.
Conversely, a company that has a down-
Since it is for companies to declare divi- ward trend of payouts is alarming to inves-
dends and increase their ratio for one year, tors. For example, if a company’s ratio has
a single high ratio does not mean that fallen a percentage each year for the last
much. Investors are mainly concerned five years might indicate that the compa-
with sustainable trends. ny can no longer afford to pay such high
dividends. This could be an indication of
poor operating performance.

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Dividend Yield
Explanation
-The dividend yield is a financial ratio that Investors invest their money in stocks to
measures the amount of cash dividends earn a return either by dividends or stock
distributed to common shareholders rela- appreciation. Some companies choose to
tive to the market value per share. The pay dividends on a regular basis to spur
dividend yield is used by investors to show investors’ interest. These shares are often
how their investment in stock is generating called income stocks. Other companies
either cash flows in the form of dividends choose not to issue dividends and instead
or increases in asset value by stock appre- reinvest this money in the business. These
ciation. shares are often called growth stocks.
Investors can use the dividend yield for-

mula to help analyze their return on invest-
ment in stocks.
Formula
Analysis
-Investors use the dividend yield formula A high or low dividend yield is relative to
to compute the cash flow they are get- the industry of the company. As I men-
ting from their investment in stocks. In other tioned above, tech companies rarely give
words, investors want to know how much dividends at all. So even a small dividend
dividends they are getting for every dollar might produce a high dividend yield ratio
that the stock is worth. for the tech industry. Generally, investors
want to see a yield as high as possible.
A company with a high dividend yield
pays its investors a large dividend com-
pared to the fair market value of the stock.
This means the investors are getting highly
compensated for their investments com-
pared with lower dividend yielding stocks.

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Coverage Ratios
Fixed Charge Coverage Ratio

Debt Service Coverage Ratio
Find more Coverage Ratios

Fixed Charge Coverage Ratio
Explanation
-The fixed charge coverage ratio is a fi- The fixed charge coverage ratio is very
nancial ratio that measures a firm’s ability adaptable for use with almost any fixed
to pay all of its fixed charges or expenses cost since fixed costs like lease payments,
with its income before interest and income insurance payments, and preferred divi-
taxes. The fixed charge coverage ratio is dend payments can be built into the cal-
basically an expanded version of the times culation.
interest earned ratio or the times interest
coverage ratio.
Formula
Analysis
-The fixed charge coverage ratio shows In a way, this ratio can be viewed as a sol-
investors and creditors a firm’s ability to vency ratio because it shows how easily a
make its fixed payments. Like the times in- company can pay its bills when they be-
terest ratio, this ratio is stated in numbers come due. Obviously, if a company can’t
rather than percentages. pay its lease or rent payments, it will not be
in business for much longer.
The ratio measures how many times a firm
can pay its fixed costs with its income be- Higher fixed cost ratios indicate a healthier
fore interest and taxes. In other words, it and less risky business to invest in or loan
shows how many times greater the firm’s to. Lower ratios show creditors and inves-
income is compared with its fixed costs. tors that the company can barely meet its
monthly bills.

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Debt Service Coverage Ratio
Explanation
-The debt service coverage ratio is a finan- Since this ratio measures a firm’s ability to
cial ratio that measures a company’s abil- make its current debt obligations, current
ity to service its current debts by compar- and future creditors are particularly inter-
ing its net operating income with its total est in it.
debt service obligations. In other words,
this ratio compares a company’s avail- Creditors not only want to know the cash
able cash with its current interest, principle, position and cash flow of a company, they
and sinking fund obligations. also want to know how much debt it cur-
rently owes and the available cash to pay
The debt service coverage ratio is impor- the current and future debt.
tant to both creditors and investors, but
creditors most often analyze it.
Formula
Analysis
-The debt service coverage ratio measures A ratio of less than one means that the
a firm’s ability to maintain its current debt company doesn’t generate enough op-
levels. This is why a higher ratio is always erating profits to pay its debt service and
more favorable than a lower ratio. A high- must use some of its savings.
er ratio indicates that there is more income
available to pay for debt servicing. Generally, companies with higher service
ratios tend to have more cash and are
For example, if a company had a ratio of better able to pay their debt obligations
1, that would mean that the company’s on time.
net operating profits equals its debt service
obligations. In other words, the company
generates just enough revenues to pay for
its debt servicing.

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CPA Exam Ratios to Know
Although this isn’t a comprehensive list of every financial ratio that
could appear on the CPA exam, it is a list of the most common ones.
The two sections that tend to have ratios pop up in questions are FAR
and BEC. The FAR ratios are typically more financial statement based
and the BEC ratios are more cost accounting and business manage-
ment based. If you learn these ratios, you should do fine on the exam.
Debt to Equity Ratio Days in Sales

Return on Assets Days in Inventory
Accounts Receivable Turnover Break Even Point - units and sales
Working Capital Margin of Safety
Acid Test Return on Equity
Times Interest Earned EVA
Accounts Receivable Turnover Earnings per Share
Inventory Turnover P/E ratio
Gross Profit Debt Ratio
Profit Margin Book Value per Common Share
Find more about the CPA Exam

on www.myaccountingcourse.com/cpa/
CMA Exam Ratios to Know
EBIT - Earnings before interest and taxes Inventory turnover
EBITDA - Earnings before interest, taxes, Accounts payable turnover
depreciation and amortization Days sales in receivables
EBT - Earnings before taxes Days sales in inventory
EPS - Earnings per share Days purchases in payables
ROA - Return on assets Operating cycle
ROE - Return on equity Cash cycle
ROI - Return on investment Total asset turnover
Current Ratio Fixed asset turnover
Working Capital Gross profit margin percentage
Quick Ratio Operating profit margin percentage
Cash Ratio Net profit margin percentage
Degree of financial leverage Market-to-book ratio
Degree of operating leveragej Price earnings ratio
Debt to equity ratio Book value per share
Debt to total assets ratio Diluted EPS
Fixed charge coverage Earnings yield
Interest coverage Dividend payout ratio
Cash flow to fixed charges Shareholder return
Accounts receivable turnover Breakeven point in units and dollars
Margin of safety
Find more Financial Ratios

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Quick Ratio / Acid Test Ratio

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This means that a company has a limited

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In other words, a ratio of 4 means that a

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Debt to Equity Ratio

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A debt to equity ratio of 1 would means

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Accounts Receivable Turnoverr

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Gross Margin Ratio

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Earnings Per Share

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Investors often use this ratio to evaluate

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Investors can use the dividend yield for-

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Fixed Charge Coverage Ratio

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Debt to Equity Ratio Days in Sales

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