Research for the formula and significance of the following commonly used financial ratios:

1. Ratios used to evaluate short-term financial position (short-term solvency and liquidity)
1.1. Current ratio
1.2. Acid-test ratio
1.3. Working capital ratio
1.4. Cash flow liquidity ratio
1.5. Defensive interval ratio

2. Ratios used to evaluate asset liquidity and management efficiency

2.1. Trade receivable turnover
2.2. Average collection period
2.3. Inventory turnover
2.3.1. Merchandise turnover
2.3.2. Finished goods turnover
2.3.3. Goods-in-process turnover
2.3.4. Raw materials turnover
2.3.5. Days supply in inventory
2.4. Working capital turnover
2.5. Current assets turnover
2.6. Payable turnover
2.7. Operating cycle
2.8. Days cash
2.9. Free cash flow
2.10. Assets turnover
2.11. Plant assets turnover
2.12. Capital intensity ratio

3. Ratios used to evaluate long-term financial position or stability / leverage

3.1. Debt ratio

 Debt ratio is a solvency ratio that measures a firm’s total liabilities as a percentage of its
total assets. In a sense, the debt ratio shows a company’s ability to pay off its liabilities
with its assets. In other words, this shows how many assets the company must sell in
order to pay off all of its liabilities.
 This ratio measures the financial leverage of a company. Companies with higher levels
of liabilities compared with assets are considered highly leveraged and more risky for
lenders.
 This helps investors and creditors analysis the overall debt burden on the company as
well as the firm’s ability to pay off the debt in future, uncertain economic times.
3.2. Equity ratio

 The equity ratio is an investment leverage or solvency ratio that measures the amount of
assets that are financed by owners’ investments by comparing the total equity in the
company to the total assets.
 The equity ratio highlights two important financial concepts of a solvent and sustainable
business. The first component shows how much of the total company assets are owned
 outright by the investors. In other words, after all of the liabilities are paid off, the
investors will end up with the remaining assets.
 The second component inversely shows how leveraged the company is with debt. The
equity ratio measures how much of a firm’s assets were financed by investors. In other
words, this is the investors’ stake in the company. This is what they are on the hook for.
The inverse of this calculation shows the amount of assets that were financed by debt.
Companies with higher equity ratios show new investors and creditors that investors
believe in the company and are willing to finance it with their investments.
3.3. Debt to equity ratio

 The debt to equity ratio is a financial, liquidity ratio that compares a company’s total
debt to total equity. The debt to equity ratio shows the percentage of company financing
that comes from creditors and investors. A higher debt to equity ratio indicates that more
creditor financing (bank loans) is used than investor financing (shareholders).

3.4. Fixed assets to long-term liability

FIXED ASSET/ LONG TERM LIABILITIES
 The greater the ratio's value, the greater the ability to cover the long-term liabilities, and
also the debt capacity of the company (increasing the chances for gaining new long-term
liabilities in the future).
 Represents the financial position of the company and the company’s ability to meet all
its financial requirements. It shows the percentage of a company’s assets that are
financed with loans and other financial obligations that last over a year. As this ratio is
calculated yearly, decrease in the ratio would denote that the company is fairing well,
and is less dependant on debts for their business needs.
3.5. Fixed assets to total equity
FIXED ASSET/ TOTAL EQUITY
 the financial stability of a company as well as its risk of insolvency can be gauged using
equity ratios. The fixed-assets-to-equity ratio in particular measures the relative
exposure of shareholders vs. the creditors of a business. Financial leverage increases the
business risk of a company in that debt leads to fixed costs that potentially can have a
negative effect on profitability in the event that revenues sharply decrease. In addition,
the fact that debt and interest takes priority over other business interests can have a
negative impact on future operations should the company’s revenue stream dramatically
shift for the worse. As a result, the assets-to-equity ratio provides essential information
to potential creditors.
3.6. Fixed assets to total assets
FIXED ASSET/ TOTAL ASSET
 Fixed-assets-to-net-worth ratio is a financial analysis technique that shows in percentage
terms the portion of your company's total assets that is tied up with fixed assets. It shows
the extent to which the company funds are frozen in the form of fixed assets, such as
property, plant and equipment. It represents the portion of total assets that cannot be
used as working capital.
 A business must possess enough funds to pay current financial obligations at all times to
ensure continuity of business operations. Fixed-assets-to-net-worth ratio is an accounting
tool that shows you what percentages of your company’s total assets can and can’t be
used for current financial obligations. Failure to understand this tool can leave your
 company vulnerable to solvency problems caused by unexpected events and sudden
changes in business climate.
3.7. Book value per ordinary share

 The book value per share (BVPS) is calculated by taking the ratio of equity available to
common stockholders against the number of shares outstanding. When compared to the
current market value per share, the book value per share can provide information on how
a company’s stock is valued. If the value of BVPS exceeds the market value per share,
the company’s stock is deemed undervalued. The book value is used as an indicator of
the value of a company’s stock, and it can be used to predict the possible market price of
a share at a given time in the future.
 When calculating the book value per share of a company, we base the calculation on the
common stockholders’ equity, and the preferred stock should be excluded from the value
of equity. It is because preferred stockholders are ranked higher than common
stockholders during liquidation. The BVPS represents the value of equity that remains
after paying up all debts and the company’s assets liquidated.
3.8. Times interest earned

 The times interest earned ratio, sometimes called the interest coverage ratio, is a
coverage ratio that measures the proportionate amount of income that can be used to
cover interest expenses in the future.
 In some respects the times interest ratio is considered a solvency ratio because it
measures a firm’s ability to make interest and debt service payments. Since these interest
payments are usually made on a long-term basis, they are often treated as an ongoing,
fixed expense. As with most fixed expenses, if the company can’t make the payments, it
could go bankrupt and cease to exist. Thus, this ratio could be considered a solvency
ratio.

3.9. Times preference dividend requirement earned

 Preferred stock is one of the many ways a company can choose to raise capital. It
promises a predetermined dividend to be paid on a quarterly or annual basis for
perpetuity
 The times preferred dividends earned, also known as the dividend coverage ratio, is a
coverage ratio which measures a company’s ability to pay its preferred stock dividend,
based on its net income.
 Preferred stock holders, as well as common stock holders, use this ratio to gauge the
likelihood of a company missing its dividend payment
3.10. Times fixed charges earned

4. Ratios used to measure profitability and returns to investors

4.1. Gross profit margin
  Gross profit margin is a profitability ratio that calculates the percentage of sales that
exceed the cost of goods sold. In other words, it measures how efficiently a company
uses its materials and labor to produce and sell products profitably. You can think of it
as the amount of money from product sales left over after all of the direct costs
associated with manufacturing the product have been paid. These direct costs are
typically called cost of goods sold or COGS and usually consist of raw materials and
direct labor.

 The gross profit ratio is important because it shows management and investors how
profitable the core business activities are without taking into consideration the indirect
costs. In other words, it shows how efficiently a company can produce and sell its
products. This gives investors a key insight into how healthy the company actually is.
For instance, a company with a seemingly healthy net income on the bottom line could
actually be dying. The gross profit percentage could be negative, and the net income
could be coming from other one-time operations. The company could be losing money
on every product they produce, but staying a float because of a one-time insurance
payout.
 That is why it is almost always listed on front page of the income statement in one form
or another. Let’s take a look at how to calculate gross profit and what it’s used for.

4.2. Operating profit margin

 The operating margin ratio, also known as the operating profit margin, is a profitability
ratio that measures what percentage of total revenues is made up by operating income. In
other words, the operating margin ratio demonstrates how much revenues are left over
after all the variable or operating costs have been paid. Conversely, this ratio shows what
proportion of revenues is available to cover non-operating costs like interest expense.
 This ratio is important to both creditors and investors because it helps show how strong
and profitable a company’s operations are. For instance, a company that receives 30
percent of its revenue from its operations means that it is running its operations smoothly
and this income supports the company. It also means this company depends on the
income from operations. If operations start to decline, the company will have to find a
new way to generate income.
 Conversely, a company that only converts 3 percent of its revenue to operating income
can be questionable to investors and creditors. The auto industry made a switch like this
in the 1990’s. GM was making more money on financing cars than actually building and
selling the cars themselves. Obviously, this did not turn out very well for them. GM is a
prime example of why this ratio is important.
4.3. Net profit margin / return on sales

 The net profit margin ratio, also called net margin, is a profitability metric that measures
what percentage of each dollar earned by a business ends up as profit at the end of the
year. In other words, it shows how much net income a business makes from each dollar
of sales.
 Investors and analysts typically use net margin to gauge how efficiently a company is
managed and forecast future profitability based on management’s sales forecasts. By
 comparing net income to total sales, investors can see what percentage of revenues goes
to paying operating and non-operating expenses and what percentage is left over to pay
shareholders or reinvest in the company.
 A higher margin is always better than a lower margin because it means that the company
is able to translate more of its sales into profits at the end of the period. Keep in mind
that margins change drastically between industries and just become one industry has a
lower average margin than another doesn’t mean that it is less profitable. Industries, like
retailing, might have a lower average margin than other industries, but they make up for
it in sheer volume of sales making them more profitable in total dollars.
4.4. Cash flow margin
Cash flow margin = Cash flows from operating activities / Net sales
 The cash flow margin is one of the more important profitability ratios for a company. It
tells how well the company converts sales to cash—and cash is of critical importance
because it's required to pay expenses. The conversion of sales dollars to cash is vital.
 Profitability ratios show a company's overall efficiency and performance. These ratios
can be divided into two types: margins and returns.
 Ratios that show margins represent the firm's ability to translate sales dollars into profits
at various stages of measurement. Ratios that show returns represent the firm's ability to
measure the overall efficiency of the firm in generating returns for its shareholders.
 Levered free cash flow is the "free" cash flow that's left after a business has met its
financial obligations on any accrued debt. The levered cash flow is the amount of cash
left over for stockholders after all financial obligations are met.
4.5. Return on assets

 The return on assets ratio, often called the return on total assets, is a profitability ratio
that measures the net income produced by total assets during a period by comparing net
income to the average total assets. In other words, the return on assets ratio or ROA
measures how efficiently a company can manage its assets to produce profits during a
period.
 Since company assets’ sole purpose is to generate revenues and produce profits, this
ratio helps both management and investors see how well the company can convert its
investments in assets into profits. You can look at ROA as a return on investment for the
company since capital assets are often the biggest investment for most companies. In this
case, the company invests money into capital assets and the return is measured in profits.
4.6. Return on equity

 The return on equity ratio or ROE is a profitability ratio that measures the ability of a
firm to generate profits from its shareholders investments in the company. In other
words, the return on equity ratio shows how much profit each dollar of common
stockholders’ equity generates.
 So a return on 1 means that every dollar of common stockholders’ equity generates 1
dollar of net income. This is an important measurement for potential investors because
they want to see how efficiently a company will use their money to generate net income.
 ROE is also and indicator of how effective management is at using equity financing to
fund operations and grow the company.
4.7. Earnings per share
  Earning per share (EPS), also called net income per share, is a market prospect ratio that
measures the amount of net income earned per share of stock outstanding. In other
words, this is the amount of money each share of stock would receive if all of the profits
were distributed to the outstanding shares at the end of the year.
 Earnings per share is also a calculation that shows how profitable a company is on a
shareholder basis. So a larger company’s profits per share can be compared to smaller
company’s profits per share. Obviously, this calculation is heavily influenced on how
many shares are outstanding. Thus, a larger company will have to split its earning
amongst many more shares of stock compared to a smaller company.
4.8. Price-earnings ratio

 The price earnings ratio, often called the P/E ratio or price to earnings ratio, is a market
prospect ratio that calculates the market value of a stock relative to its earnings by
comparing the market price per share by the earnings per share. In other words, the price
earnings ratio shows what the market is willing to pay for a stock based on its current
earnings.
 Investors often use this ratio to evaluate what a stock’s fair market value should be by
predicting future earnings per share. Companies with higher future earnings are usually
expected to issue higher dividends or have appreciating stock in the future.
 Obviously, fair market value of a stock is based on more than just predicted future
earnings. Investor speculation and demand also help increase a share’s price over time.
 The PE ratio helps investors analyze how much they should pay for a stock based on its
current earnings. This is why the price to earnings ratio is often called a price multiple or
earnings multiple. Investors use this ratio to decide what multiple of earnings a share is
worth. In other words, how many times earnings they are willing to pay.
4.9. Dividend payout

 The dividend payout ratio measures the percentage of net income that is distributed to
shareholders in the form of dividends during the year. In other words, this ratio shows
the portion of profits the company decides to keep to fund operations and the portion of
profits that is given to its shareholders.
 Investors are particularly interested in the dividend payout ratio because they want to
know if companies are paying out a reasonable portion of net income to investors. For
instance, most start up companies and tech companies rarely give dividends at all. In
fact, Apple, a company formed in the 1970s, just gave its first dividend to shareholders
in 2012.
 Conversely, some companies want to spur investors’ interest so much that they are
willing to pay out unreasonably high dividend percentages. Inventors can see that these
dividend rates can’t be sustained very long because the company will eventually need
money for its operations.
4.10. Dividend yield
  The dividend yield is a financial ratio that measures the amount of cash dividends
distributed to common shareholders relative to the market value per share. The dividend
yield is used by investors to show how their investment in stock is generating either cash
flows in the form of dividends or increases in asset value by stock appreciation.
 Investors invest their money in stocks to earn a return either by dividends or stock
appreciation. Some companies choose to pay dividends on a regular basis to spur
investors’ interest. These shares are often called income stocks. Other companies choose
not to issue dividends and instead reinvest this money in the business. These shares are
often called growth stocks.
 Investors can use the dividend yield formula to help analyze their return on investment
in stocks.
4.11. Dividend per share
DPS = (total dividends paid out over a period - any special dividends)
÷ (shares outstanding).
 DPS is the number of declared dividends issued by a company for every ordinary
share outstanding. It is the number of dividends each shareholder of a company
receives on a per-share basis. Ordinary shares, or common shares, are the basic
voting shares of a corporation. Shareholders are usually allowed one vote per
share and do not have any predetermined dividend amounts.
 Dividends per share are calculated by dividing the total number of dividends paid
out by a company, including interim dividends, over a period of time, by the
number of shares outstanding. A company's DPS is often derived using the
dividend paid in the most recent quarter, which is also used to calculate the
dividend yield.
4.12. Return on current assets
Return on Total Assets=EBIT/Average Total Assets
where:EBIT=earnings befor interest and taxes
 The greater a company's earnings in proportion to its assets (and the greater the
coefficient from this calculation), the more effectively that company is said to be using
its assets. The ROTA, expressed as a percentage or decimal, provides insight into how
much money is generated from each dollar invested into the organization.
 This allows the organization to see the relationship between its resources and its income,
and it can provide a point of comparison to determine if an organization is using its
assets more or less effectively than it had previously. In circumstances where the
company earns a new dollar for each dollar invested in it, the ROTA is said to be one, or
100 percent.

4.13. Return per turnover of current assets

 The asset turnover ratio is an efficiency ratio that measures a company’s ability to
generate sales from its assets by comparing net sales with average total assets. In other
words, this ratio shows how efficiently a company can use its assets to generate sales.
 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.