COMMON RATIOS USED IN FINANCIAL ANALYSIS

In the previous section, we focused on ratios resulting from common-size analysis. In this section, we
expand the discussion to include other commonly used financial ratios and the broad classes into which
they are categorized. There is some overlap with common-size financial statement ratios. For example, a
common indicator of profitability is the net profit margin, which is calculated as net income divided by
sales. This ratio appears on a vertical common-size income statement. Other ratios involve information
from multiple financial statements or even data from outside the financial statements.

Categories of Financial Ratios

Category Description
Activity Activity ratios measure how
efficiently a company performs day-to-
day tasks, such as the collection of
receivables and management of
inventory.
Liquidity Liquidity ratios measure the
company’s ability to meet its short-
term obligations.
Solvency Solvency ratios measure a
company’s ability to meet long-term
obligations. Subsets of these ratios
are also known as “leverage” and
“long-term debt” ratios.
Profitability Profitability ratios measure the
company’s ability to generate profits
from its resources (assets).
Valuation Valuation ratios measure the
quantity of an asset or flow (e.g.,
earnings) associated with ownership
of a specified claim (e.g., a share or
ownership of the enterprise).

These categories are not mutually exclusive; some ratios are useful in measuring multiple aspects of the business.
For example, an activity ratio measuring how quickly a company collects accounts receivable is also useful in
assessing the company’s liquidity because collection of revenues increases cash. Some profitability ratios also
reflect the operating efficiency of the business. In summary, analysts appropriately use certain ratios to evaluate
multiple aspects of the business. Analysts also need to be aware of variations in industry practice in the calculation
of financial ratios. In the text that follows, alternative views on ratio calculations are often provided.
 Activity Ratios

Activity Ratios Numerator Denominator

Inventory turnover Cost of sales or cost of Average inventory
goods sold
Days of inventory on Number of days in Inventory turnover
hand (DOH) period
Receivables turnover Revenue Average receivables
Days of sales Number of days in Receivables turnover
outstanding (DSO) period
Payables turnover Purchases Average trade payables
Number of days of Number of days in Payables turnover
payables period
Working capital Revenue Average working capital
turnover

Fixed asset turnover Revenue Average net fixed

assets
Total asset turnover Revenue Average total assets

Liquidity ratios

Liquidity Ratios Numerator Denominator

Current ratio Current assets Current liabilities
Quick ratio Cash + Short-term Current liabilities
marketable investments
+ Receivables
Cash ratio Cash + Short-term Current liabilities
marketable investments
Defensive interval ratio Cash + Short-term Daily cash expenditures
marketable investments
+ Receivables
Additional Liquidity Measure
Cash conversion DOH + DSO – Number of days of payables
cycle(net operating
cycle)

Solvency ratios

Solvency Ratios Numerator Denominator

Debt Ratios
Debt-to-assets ratioa Total debtb Total assets
Debt-to-capital ratio Total debtb Total debtb + Total
shareholders’ equity
Debt-to-equity ratio Total debtb Total shareholders’
equity
Financial leverage ratioc Average total assets Average total equity
Debt-to-EBITDA Total debt EBITDA

Interest coverage EBIT Interest payments

Fixed charge coverage EBIT + Lease payments Interest payments +
Lease payments

Profitability ratios

Return on Salesa
Gross profit margin Gross profit Revenue
Operating profit margin Operating incomeb Revenue
Pretax margin EBT (earnings before Revenue
tax but after interest)
Net profit margin Net income Revenue

Return on Investment
Operating ROA Operating income Average total assets
ROA Net income Average total assets
Return on total capital EBIT Average short- and
long-term debt and
equity
ROE Net income Average total equity
Return on common Net income – Preferred Average common equity
equity dividends

DU PONT

Valuation ratios

Valuation Ratios Numerator Denominator

P/E Price per share Earnings per share
P/CF Price per share Cash flow per share
P/S Price per share Sales per share
P/BV Price per share Book value per share

Per-Share Quantities Numerator Denominator

Basic EPS Net income minus Weighted average
preferred dividends number of ordinary
shares outstanding
Diluted EPS Adjusted income Weighted average
available for ordinary number of ordinary and
shares, reflecting potential ordinary
conversion of dilutive shares outstanding
securities
Cash flow per share Cash flow from Weighted average
operations number of shares
outstanding
EBITDA per share EBITDA Weighted average
number of shares
outstanding
Dividends per share Common dividends Weighted average
declared number of ordinary
shares outstanding

Dividend-Related Numerator Denominator

Quantities
Dividend payout ratio Common share Net income attributable
dividends to common shares
Retention rate (b) Net income attributable Net income attributable
to common shares – to common shares
Common share dividends
Sustainable growth rate b × ROE

Industry specific ratios

Financial Sector Numerator Denominator

Ratios
Capital Various components of Various measures such
adequacy—banks capital as risk-weighted assets,
market risk exposure, or
level of operational risk
assumed
Monetary reserve Reserves held at central Specified deposit
requirement (Cash bank liabilities
reserve ratio)
Liquid asset Approved “readily Specified deposit
requirement marketable” securities liabilities
Net interest margin Net interest income Total interest-earning
assets
Retail Ratios Numerator Denominator
Same (or comparable) Average revenue growth Not applicable
store sales year over year for stores
open in both periods
Sales per square meter Revenue Total retail space in
(or square foot) square meters (or
square feet

Service Companies Numerator Denominator

Revenue per employee Revenue Total number of
employees
Net income per Net income Total number of
employee employees